Does J.C. Penney's CEO Deserve This Big Raise?


Myron E. -- Mike -- Ullman. Source: J.C. Penney

According to recent regulatory filings, J.C. Penney CEO Myron Ullman will receive a big increase in compensation this year. Ullman will make $1.5 million in salary during 2014; he will also be eligible for $5.5 million in stock awards and a $3 million bonus, for a total potential compensation of $10 million during the year.

This is a considerable increase versus the $2.4 million he made in fiscal 2013, which included $810,606 in salary and an extra $1.6 million in other compensation, such as the personal use of corporate aircraft. Is this raise deserved? Does it mean J.C. Penney is on the road to recovery?

Reasons for hope
Shares in the long-suffering department store chain have risen by more than 55% over the last month. The stock is notably volatile, and market reactions are usually exaggerated in the short term; nevertheless, this explosive rise clearly indicates that investors see improved prospects for the company.

On Feb., 26 J.C. Penney announced earnings for the quarter and full-year ended on Feb. 1, and the market received the report with considerable optimism.

Excluding the 53rd week in 2012, total year-over-year sales during the quarter increased by 1.6% to $3.78 billion. Comparable-store sales grew by 2% versus depressed levels in the same period of the prior year; online sales increased by a big 26.3%, but still represented a modest $381 million during the period.

Gross margin came in at 28.4%, an increase of 460 basis points versus 23.8% in the year-ago quarter. However, this is still materially lower than the gross profit margin reported by other companies in the industry.

Even in a challenging period for the company, Dillard´s reported a higher gross margin of 32.8% in its retail operations during the quarter. Kohl´s reported a gross margin of 34% in the last quarter, while Macy´s significantly outperformed the competition with a gross margin of 40.6% during the quarter ended on Feb. 1.

J.C. Penney is still losing money on an operating level, but the company generated positive free cash flow of $246 million during the quarter, and it ended the year with more than $2 billion in available excess liquidity.

Importantly, forward guidance was quite optimistic: Management expects comparable-store sales to increase between 3% and 5% during the first quarter of fiscal 2014 and by mid-single digits during the full fiscal year. In addition, the company is forecasting gross margin to "improve significantly" versus 2013, both in the next quarter and through the full year.

Reasons for concern
J.C. Penny in November announced a 10.1% boost in comparable-store sales during the month. The 2% overall increase for the November to January quarter suggests considerable declines in comparable-store sales during December and January.

For this reason, it's hard to tell yet whether sales are really stabilizing, or if J.C. Penney delivered a short-term bounce in November via unsustainably aggressive promotions.

The company will need to increase profit margin in order to recover profitability and turn the business around. This will be no easy task in the savagely competitive environment affecting retailers in general and department stores in particular over the last several quarters.

Management's guidance for a middle single-digit increase in comparable-store sales during the coming year, in combination with a significant improvement in margins, may be too optimistic considering industry conditions.

Industry outperformer Macy´s reported an increase of 2.3% in comparable-store sales, including departments licensed to third parties, during the last quarter. Dillard´s delivered a similar increase of 2% in comparable-store revenue, while Kohl´s suffered a decline of 2% during the period.

J. C. Penney´s guidance for the coming year would mean a considerable improvement versus the declining sales and margins the company reported over the last several years. However, this guidance seems to imply that J.C. Penney can outgrow the competition while improving margins via a combination of lower costs and stronger prices, certainly a huge challenge for manangement.

Bottom line
Ullman has not proven a consistent turnaround in sales at this stage, the improvement reported in the fourth quarter of fiscal 2013 seems to be mostly based on a strong performance during November alone. Even if J.C. Penney can stabilize sales, the company will need to improve margins in order to recover financial stability. Forward guidance sounds quite confident, but it may turn out to be excessively optimistic considering the aggressively competitive environment in the retail industry.

J.C. Penney still has a long way to go before we can say the company is definitively on the path to a sustainable turnaround.

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