J.C. Penney: The Good, the Bad, and the Ugly
What's the price a company pays for not knowing what it is, and what it stands for? If it's in retail, such a situation can be akin to a death sentence. After J.C. Penney's latest earnings release, it's clear that the company is discovering this lesson the hard way.
The retailer decided to shift its focus and pricing strategy under former CEO Ron Johnson, and though he has since left, the damage from that ill-fated decision still lingers. Current management, under the direction of CEO Myran Ullman -- who is on his second go-round running J.C. Penney -- is bringing back its tried-and-true pricing strategy.
How that transition plays out remains to be seen, but the company's earnings release offered some clues.
The major headline that's been offering hope to J.C. Penney investors lately is the fact that same-store sales were able to grow during the month of October for the first time since 2011. Many take this as a sign that customers are coming back to the company they once knew.
Increased sales alone, however, are not enough to mean that J.C. Penney is out of the woods. If those sales are in the form of steep markdowns, it means that the company isn't making much money; it also means that customers are coming back for some ridiculous deals, and not because of loyalty to Penney.
But management put those fears to rest by telling analysts that it expects gross margins to improve both sequentially and year over year during the holiday season. That means they should come in above this quarter's 29.5% clip. More than anything, I think this is why shares of the company are up near 10% in early trading.
Unfortunately, a return to profitability isn't coming in the immediate future. Ullman said that J.C. Penney still has a glut of inventory brought in during Johnson's tenure that simply did not resonate with customers.
If there were no repercussions, I have no doubt that Ullman would get rid of this inventory in a second -- but that wouldn't be a prudent financial decision. Instead, the company needs to continue selling these products at steep markdowns in order to get rid of it all.
For the quarter, gross margins declined 300 basis points. Ullman said that two-thirds of that decline was due to markdowns on inventory the company is trying to get off its hands. He expects a similar trend in the fourth quarter, and then for the problem to eventually go away.
Companies can sometimes play tricks that lead us to believe things are better than they are. J.C. Penney claimed that comparable-store sales were up during the month of October. They failed to mention, however, that e-commerce sales are included in this equation.
If we were to back out the solid performance of jcp.com, sales for the company would have declined 7.4% for the quarter. And because of how the numbers are reported, it's impossible to tell how same-store sales of brick-and-mortars fared during October.
Furthermore, the company continues to bleed cash. During the quarter, J.C. Penney lost almost $900 million in free cash flow. That brings the total cash burn for the company to more than $3 billion for 2013.
When it comes to operating metrics, J.C. Penney is still worst-in-class.
A Foolish verdict
Despite the litany of discouraging numbers coming out of the company's earnings release, it's important to remember that the market is more concerned with what a company is going to do than what it has done.
It's important to take J.C. Penney's debt situation into consideration -- given how much cash it has been burning -- and the company's overall valuation.
The debt situation actually doesn't seem as bad from this vantage point, and J.C. Penney looks downright cheap based on sales. But there's a reason for that: Macy's is growing sales, and Kohl's is stagnant. Both companies are profitable. J.C. Penney, on the other hand, is bleeding both customers and cash.
The holiday season will be critically important for J.C. Penney. After promising higher gross margins in the fourth quarter, Ullman needs to deliver. And even if this does happen, same-store sales, as well as the company's continued burn of cash, needs to show significant improvement.
Better options in retail
To learn about two retailers with especially good prospects, take a look at The Motley Fool's special free report: "The Death of Wal-Mart: The Real Cash Kings Changing the Face of Retail." In it, you'll see how these two cash kings are able to consistently outperform, and how they're planning to ride the waves of retail's changing tide. One of these two stocks makes up a whopping 12% of my real-life holdings. You can access the report and discover the names of these two companies by clicking here.
The article J.C. Penney: The Good, the Bad, and the Ugly originally appeared on Fool.com.Fool contributor Brian Stoffel 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.