J.C. Penney Proves Its Turnaround Is Working

Boy, Wall Street can be a tough crowd to please. J.C. Penney is just beginning its turnaround -- like, we're talking a couple of months "just beginning" -- and analysts are already asking for the proof that it's taking hold. 

Losses quadrupled in the just-reported third quarter, gross margins worsened, and same-store sales were down nearly 5%, making it seem the pros are right as to where the company is in its recovery. But before being so hasty, let's consider what's going on.

First, ex-CEO Ron Johnson was only ousted in April. Whatever the demerits of his policies were -- and for critics they were legion, even if there were some very good reasons they were tried -- it still takes some time to identify what went wrong, what worked, and how best to address it.

For example, abandoning the shopper's favored doorbuster sales model for an everyday-low-pricing policy, Johnson exacerbated an exodus that was already in motion before he arrived, so it was clear that it needed to be one of the first fixes the new management team had to put in place. But it's not so easy to get customers to return simply by reversing course.

Still, there are signs it's beginning to work. Sales this quarter were down 5% from the year-ago period, but their rapid decline was stanched and the gap was sharply narrowed from the second quarter when sales fell 12% year over year. Furthermore, online sales surged nearly 25% and are improving sequentially as well. They're only a small component of the overall sales picture, to be sure, but e-commerce will increasingly take on greater importance for all retailers.

Perhaps most significant of all is that customers are returning. Same-store sales, while down for the quarter, started trending higher again in October and were 710 basis points above second-quarter comps. Kohl's reported same-store sales that fell 0.1% in the quarter, compared to an expectation of a 0.7% increase, suggesting Penney's is not alone in this boat, but its metrics are improving.

Moreover, November traffic also turned positive again largely as a result of its "Biggest Sale of Them All" promotion. With Black Friday coming and Christmas shopping beginning in earnest, there's no reason to think those trends won't continue. Indeed, the retailer says it still fully expects to have positive comps for the fourth quarter.

Because the customer was looking for sales and Penney's is delivering on that expectation, its natural margins wouldn't be as robust as they otherwise might be. Yet even there we're seeing that despite gross profits coming in at 29.5% of sales, down from 32.5% last year and essentially unchanged sequentially, they have improved each month across the quarter. Macy's also had to be promotional this quarter, and while its numbers were fairly robust, it experienced margin compression due to the discounting. 

On the financial front, Penney was even able to repay $200 million in principal on its revolving-credit facility this quarter. With total liquidity of $1.7 billion now and an expected $2 billion after the fourth quarter, even the cash problems it has -- such as $5.6 billion in debt and negative free cash flow of around $3 billion -- look a bit less dire than they once did.

This isn't a clear picture of health by any stretch of the imagination. There are still big hurdles to clear, and the company continues to burn cash, but what it does show me is that J.C. Penney is turning its business around. Investors who have a slightly longer timeline than the "what have you done for me lately" mind-set of Wall Street just might find they can profit right alongside the retailer.

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The article J.C. Penney Proves Its Turnaround Is Working originally appeared on Fool.com.

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