The JCPenney Love Affair Needs a Gut Check

The excitement surrounding J.C. Penney is almost comical, but ultimately sad. There are people out there saying that J.C. Penney is 2014's top retailer -- an assertion that is downright odd and seemingly devoid of thought. To the company's credit, recent same-store sales and top-line revenue are a welcome departure from the cascading figures that most have come to associate with the department store, but remember that the bar was set low --very, very low. Investors and analysts need to get a grip here. J.C. Penney is far from being out of the weeds, and the rush to get into the stock is outrageous.

Let's get the good news out of the way. J.C. Penney delivered 6.2% same-store sales growth during a period in which most retailers couldn't point to much else other than poor weather conditions. Margins improved, and overall results came in ahead of both internal and external expectations. This marks a respectable departure from the company's recent history, as J.C. Penney has now delivered two quarters of positive trends.

Investors should note that the company has updated its same-store sales calculation in an effort to "better reflect year-over-year comparability." This means that, going forward, J.C. Penney will not include expected sales returns and liquidation sales. Obviously, this would consistently generate higher same-store sales figures (management mentioned that the just-ended quarter would have reflected same-store gains of 7.4% under the new formula), and it's something to keep in mind when looking at guidance. For the current quarter and full year, J.C. Penney expects same-store sales gains in the mid single digits.

The report was undeniably bullish, but the numbers need to be taken in context. In the year-ago quarter, same-store sales had dipped down more than 16%, indicating a two-year decline of roughly 10%. This past quarter's top-line sales reflect a $300 million decrease from 2012's first quarter. While it's nonetheless an encouraging thing that J.C. Penney has reversed the trend, investors need to keep in mind the value received for the price paid.

The deal
The high estimate for full-year 2016 earnings is $0.05 per share, implying a two-year forward earnings ratio of about 190 times. The average estimate is more than a $1-per-share loss, but we are being optimistic here. Even if J.C. Penney executes perfectly over the next few years and achieves, say, $0.10-per-share earnings for full-year 2018, investors are still ponying up an outrageous price and taking on considerable downside risk.

The risk lies in J.C. Penney's strategy, which is officially to try to get back to where it was when things started going wrong. It's called a legacy strategy, and it works when you have a legacy that people want back. While J.C. Penney's downward drama didn't really kick in until Ron Johnson shook things up, it wasn't doing well before (hence Mr. Johnson coming into the picture to begin with).

We can quietly celebrate the fact that J.C. Penney isn't bleeding for the moment, and that one day it may even start to generate meaningful free cash, but is this really a cause to jump into the stock? At these levels, the answer is a definitive no.

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