Don't Let J.C. Penney Fool You

Don't Let J.C. Penney Fool You

J.C. Penney stock has risen a whopping 12% since the company announced same-store sales for the month of October. Some now believe a turnaround is possible, and that J.C. Penney's valuation makes it cheap. However, a comparison with peers Best Buy and Macy's shows that the truth might be to the contrary.

Have we found light at the end of the tunnel?
For the last two years J.C. Penney has been in a bit of a death spiral. The company saw its sales decline 25% in its 2012 fiscal year, and in its last quarter revenue declined another 12% on top of its 2012 losses.

Simply put, there has been no light at the end of the tunnel for this retailer. Its operating margin is negative 15%. It had a net loss of $1.6 billion over the last 12 months. With $1.5 billion in cash at the end of its last quarter, J.C. Penney recently completed an $800 million equity offering just to ensure that it can pay bills and keep the doors open for another two years.

Hence, an investment in J.C. Penney is a big risk. In fact, with 52% of its float being short, there are just as many people betting on substantial declines as those who believe in a resurgence. With the stock losing 50% of its value over the last 12 months, bears have clearly been right to date. However, bulls are now trying to play the "valuation card" and J.C. Penney's recent monthly same-store sales increase as reasons to be long the stock.

The valuation card has problems
With the emergence of e-commerce and price-matching, margins in retail are scarce. This in combination with a consumer who has been particularly fickle over the last year has created a tough environment for companies in this space. Therefore, many retail investors and analysts have turned to same-store sales and total revenue growth as leading indicators of a company's health and its future.

This brings up a good point relating to J.C. Penney: We're talking about a company that has posted double-digit revenue declines over the last year with industry-worst margins. The only bright sides are its one month of positive same-store sales growth and the fact that it trades at 0.15 times sales -- the valuation card I refer to is J.C. Penney's price-to-sales ratio.

However, let's consider that retailers Best Buy and Macy's trade at 0.3 and 0.6 times sales, respectively. Some investors will note that J.C. Penney is cheaper, but it is cheaper for a reason, as companies that operate more efficiently are theoretically always awarded with larger premiums.

Long-term certainty versus uncertainty
In particular, Best Buy is not what anyone would call a fast-growing company. According to Cleveland Research, the company is on pace to report comparable-store sales growth of 2.5% in the third quarter. This should translate to slight year-over-year revenue growth. However, the bigger strength and what makes Best Buy deserving of its premium to J.C. Penney is that its operating margin is far better, at 2.2%.

Moreover, Best Buy operates in a technology-retail environment that is even more price-competitive than clothing retail. Yet, its margins have risen drastically this year and are consistently positive. In addition, UBS believes Best Buy could earn about $3.50 per share in profit by 2015. Hence, despite Best Buy's one-year 180% return, it trades at just 12 times this earnings estimate for 2015. We don't even know if J.C. Penney's doors will be open in 2015, or how the company will finance operations at that point in time.

Growth and profit is worthy of premium
Macy's operates in nearly the same retail environment as J.C. Penney, but it is on a whole different operational level. Macy's is very profitable with an operating margin over 9%m and it is growing rapidly in a slow-growing industry.

In Macy's third quarter, total sales grew 3.3% year over year and comparable sales grew 3.5% in the same period. Hence, with more consumers walking in the doors of existing stores, Macy's is able to maintain its high margins despite industrywide discounting.

Moreover, Macy's is projecting comparable-sales growth of 2.5% to 4% for the remainder of the year, which is far better than the once-in-a-blue-moon 0.9% monthly comparable-sales growth for J.C. Penney. Thus, Macy's, with its growth and margins, is worth its premium, and far safer than its peer J.C. Penney.

Final thoughts
Best Buy shows how truly pathetically J.C. Penney is performing in regard to margins; Macy's gives us a look at a company that is stealing market share rather than losing it. Surprisingly, neither of these two companies are much more expensive than J.C. Penney.

With that said, I'll admit that it's nice to see a positive month of comps growth from J.C. Penney. However, the company gave us no information about inventory, profits, or cash burn, nor did it go into detail about overall traffic still being lower year over year. With these questions unanswered and given the company's history, it seems like a rather big risk to give J.C. Penney the benefit of the doubt. Personally, I'd rather pay a slight premium for market leaders instead of being fooled into believing that the retailer is in fact turning its bad fortunes around.

Be a Fool, not a fool -- learn from Buffett
Warren Buffett has made billions through his investing and he wants you to be able to invest like him. Through the years, Buffett has offered up investing tips to shareholders of Berkshire Hathaway. Now you can tap into the best of Warren Buffett's wisdom in a new special report from The Motley Fool. Click here now for a free copy of this invaluable report.

The article Don't Let J.C. Penney Fool You originally appeared on

Fool contributor Brian Nichols has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.