Don't Get Caught Up in the J.C. Penney Hype

Shares of J.C. Penney plunged to a multiyear low of $13.55 in early April, following the announcement that CEO Ron Johnson had been replaced by his predecessor, Mike Ullman. The decision to remove Johnson dispelled any lingering hopes that his turnaround plan for the company would succeed. Moreover, the choice of Ullman -- who had been pushed out less than two years before because of the company's underperformance -- was not particularly inspiring.

However, J.C. Penney shares have since rallied more than 35% from that early April low, closing at $18.62 on Tuesday.

JCP Chart
JCP Chart

J.C. Penney 1-month price chart; data by YCharts.

Investors shouldn't be fooled by the wild short-term fluctuations in J.C. Penney's stock price. The company hasn't done anything to suggest that it will return to profitability in the foreseeable future.

J.C. Penney reset
This month, J.C. Penney has tried to recover from the damage done to its brand by the company's rapid strategy changes last year. J.C. Penney began by airing a TV spot that "apologized" to customers. The big message from the commercial was that J.C. Penney was listening and responding to customer feedback and wanted previously loyal customers to give J.C. Penney a second chance.

This week, J.C. Penney introduced a new commercial, thanking those customers who came back over the past two weeks. Indeed, Cleveland Research released a report on Monday claiming that J.C. Penney had achieved significant improvement in sales and traffic this month. While it's good that people are returning to J.C. Penney, it won't necessarily improve profits, because the reintroduction of big discounts and coupons could significantly depress the company's gross margin.

Last weekend, J.C. Penney ran a Mother's Day sale and promoted discounts of as much as 40% as "doorbusters" (a term usually reserved for Black Friday weekend). The combination of bigger deals, more newspaper advertising, and the recent TV ads apparently brought more customers into J.C. Penney stores. However, investors should remember that J.C. Penney recently disclosed that Q1 revenue dropped by 16.4%, following a 20.1% decline in Q1 FY12. In other words, the bar for increased traffic and sales is very low right now.

Furthermore, while J.C. Penney has been raising some "everyday" prices recently to make room for discounts, the highly promotional style it's reintroducing will affect gross margin. The impact can be offset somewhat by selling less merchandise on clearance, but the net effect will probably be negative for the time being, because J.C. Penney will need to use particularly aggressive promotions to bring back customers who have taken their business elsewhere, such as Macy's, and TJX's T.J. Maxx and Marshalls stores.

Competitors won't roll over
J.C. Penney would gladly accept slightly lower gross margin in the nearmterm if that would allow it to quickly regain the revenue it has lost since the beginning of 2012. However, competitors such as Macy's and TJX, which have benefited from J.C. Penney's recent struggles, won't allow the company to win back customers without a fight. Those competitors are likely to increase their own promotional activity if necessary to sustain their market share gains.

The journey back from J.C. Penney's terrible 2012 will therefore be a long, hard slog, and there's no guarantee that the company will succeed. J.C. Penney needs to regain billions of dollars of lost sales to remain a viable enterprise. As a result, analysts don't expect the red ink to end anytime soon. Investors should probably put their hard-earned money elsewhere.

More perspective on JCP
J.C. Penney's stock cratered under Ron Johnson's leadership, but could new CEO Mike Ullman present the opportunity investors have been waiting for? If you're wondering whether J.C. Penney is a buy today, you're invited to claim a copy of The Motley Fool's must-read report on the company. Learn everything you need to know about Penney's turnaround -- or lack thereof. Simply click here now for instant access.

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