J.C. Penney Turnaround Hits High Gear

J.C. Penney's  CEO Myron Ullman has revealed that the ailing retailer plans to make major inventory adjustments by eliminating or trimming certain brands and focusing more on the profitable ones. Under the planned changes, brands such as JCP Menswear, some Martha Stewart-designed home furnishings, and Joe Fresh clothes will be given the boot. The firm will focus on profitable undertakings such as JCP Home and Cooks, the St. John's apparel line, and a new debutante, the Am Brielle lingerie line, which will hit stores in February 2014.

Mr. Ullman ran Penney from 2004 until 2011, when Ron Johnson took over at the helm. Since his return in April 2013, Mr. Ullman has been trying to turn around the beleaguered big-box retailer by getting back to its roots. Ron Johnson considered the firm's pricing policies, which involved marking up prices and then offering fat discounts and coupons, to be ''dubious.'' One of the first things he did when he took over as CEO was to scrap these policies in favor of offering ''more interesting'' products, including the Martha Stewart and Joe Fresh lines, at ''reasonable'' prices all of the time.

He reasoned that the firm's aggressive discounting practices not only cut into the company's pricing power, but also diminished the brand's gravitas in the eyes of consumers. His concerns are quite understandable, considering that a recent Market Forces survey ranked J.C. Penney as the fourth most-popular fashion store in the country. 

The pros for J.C. Penney outweigh the cons
J.C. Penney is already showing solid signs of recovery. Mr. Ullman declared three times in October that same-store sales were steadily improving. Sales improved 10.1% in November, versus a similar period last year.  In comparison, Macy's grew its store sales by an estimated 2.5%-3.5%, although one could argue J.C. Penney had an easier benchmark given its poor sales in 2012. The retailer has considerably more stores than leading competitor Macy's -- 1,100 to Macy's 800.

With a valuation of just 0.16 times 2012 sales, J.C. Penney looks like a good bargain compared to Macy's at 0.71 or Kohl's  at 0.63. That valuation is way below J.C. Penney's 10-year historical average of 0.56 from 1991-2011.

J.C. Penney's online sales have also been steadily improving, and they continue to do so. The company's e-commerce sales improved a healthy 24.5% in the third quarter to $266 million compared to a similar period in 2012.  The firm has been recording double-digit growth in this segment for a couple of months now: 14% in July, 10.8% in August, 25.3 % in September, and 37.6% in October. Although online sales make up less than 10% of overall sales for the company, Mr. Ullman noted that the new growth trend is very reassuring, considering that online sales plummeted a shocking 33% in 2012. J.C. Penney was the first retailer in the U.S. to surpass $1 billion in annual online sales.

J.C. Penney has been discounting its goods heavily in a bid to get rid of its old inventory. This has badly impinged on its gross margin, which fell three percentage points to 29.5% in the third quarter. That is well below the gross margins of peers Macy's at 39.9% and Kohl's at 37.5%. Mr. Ullman, however, reassured investors that improving inventory in the firm's house brands, including a wider variety of sizes and styles, would help offset the margin erosion since this merchandise has a gross margin that is five percentage points better than other goods.  Holiday store sales are expected to improve significantly by 8%-10% as more bargain hunters flock to the retailer for their Christmas shopping.
J.C. Penney has been working hard on its worrying liquidity and high cash burn rate problems. The firm is expected to have more than $2 billion in liquidity by the end of this year. Cash flow has been steadily improving from a low of ($1.147 billion) in July to the current ($898 billion).

Despite the impressive progress, the firm continues to face several challenges in the near-term. The giant retailer faces intense competition from popular retailers such as Macy's, Kohl's and Target. If the economy continues to grow sluggishly, these three might resort to offering more generous discounts on their merchandise, and this might put J.C. Penney under considerable pricing pressure. J.C. Penney simply cannot afford to mark down its merchandise any further. The current secular trend of online shopping might also induce more value-driven shoppers to turn to online discount stores such as Amazon.

The firm is also facing leverage worries. Total outstanding debt obligations stood at $5.61 billion at the end of the third quarter. A heavier debt load not only increases the firm's risk of default, but also siphons away vital resources that could have otherwise been used in the development of other merchandising strategies including mobile and e-commerce marketing.

Bottom line
J.C. Penney is not dead money, nor is it a falling knife, but rather a company firmly on the road to recovery from its past missteps. Investors have been quick to draw parallels between J.C. Penney and its ailing counterpart Sears Holdings , but Sears' case is another story altogether. J.C. Penney's investors are counting on the beleaguered retailer to make a comeback, and the firm is on the right track to achieve that.

Sears' investors, on the other hand, are counting on the firm unlocking value from its real estate properties. However, there are nagging concerns about the real value of Sears' extensive properties. The planned sale of its Lands' End property has not been well received by shareholders, after it emerged that the property might end up fetching a lot less than its $1.9 billion purchase price. Sears shares continue on what seems to be a tailspin with no end in sight, as I outlined in this bearish article.

J.C. Penney shares have been given a consensus Hold rating with a $10.10 price target. All in all, the firm is a good turnaround bet.

The article J.C. Penney Turnaround Hits High Gear originally appeared on Fool.com.

Fool contributor Joseph Gacinga has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com. 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.

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