JCPenney Earnings: Suddenly, JCP Stock Looks Like a Compelling Buy

In light of mostly disappointing second-quarter results posted by retailers Macy’s (M) and Kohl’s (KSS) earlier this week, it would have been easy to assume that JCPenney (JCP) hit the same second-quarter headwind.

JCPenney Earnings: Suddenly, JCP Stock Looks Like a Compelling BuyInstead, owners of JCP stock were treated to a pleasant earnings surprise this morning, with the department store chain topping sales as well as earnings forecasts for the quarter ending on Aug. 1.

Oh, don’t get me wrong — JCPenney still is booking big-time losses, and JCP stock remains miles away from where it was before former CEO Ron Johnson ran it into the ground. But the company is pointed in the right direction, and if JCP can just keep doing what it’s been doing, it will dig its way out of a hole and return to profitability.

It’s this trajectory that makes JCP stock a compelling long-term trade.

JCPenney Earnings

In its second quarter of fiscal 2015, JCPenney lost 45 cents per share on $2.88 billion in revenue. Both were improvements on the numbers posted for the second quarter of 2014, when the company took a loss of 56 cents per share of JCP stock on $2.8 billion worth of revenue.

Perhaps better still, this year’s Q2 earnings numbers topped the expected loss of 48 cents per share and the projected sales total of $2.86 billion. Same-store sales grew 4.1%, versus analyst expectations of 3.9% growth.

As for how the struggling company managed to post another progressive quarter, JCPenney did it the old-fashioned way … they earned it by cutting costs, selling more merchandise at higher margins and simply drawing more shoppers into its stores.

The evidence of these efforts lies in the middle portion of the income statement.

For instance, gross profit margins on merchandise sales edges up from 36% of sales to 37% of sales. And, selling and administration expenses fell from 34.4% of total sales to 31.3%.

Specifically mentioned as sales-growth and margin-growth drivers in the JCPenney earnings report were men’s clothing, home goods and fine jewelry. The company particularly highlighted success with Sephora cosmetics, which saw double-digit sales growth during Q2.

What has largely gone unnoticed — or perhaps just unappreciated — about JCPenney is how close it is to achieving profitability.

Last quarter’s loss of $138 million was a mere 1.3% of sales, versus an operating loss of 2.3% for the comparable quarter a year earlier. A few hundred more million in sales, given JCP’s gross margins and EBITDA margins, could do the trick.

While it seems superficially ridiculous to suggest “a few hundred more million” isn’t a great deal of money, for JCPenney, it isn’t. The company grew its top line by $80 million just last quarter. Its current growth rate puts true profitability within sight.

For that matter, it’s worth noting that JCP also saw positive operating cash flow last quarter. The loss was the result of capital expenditures (which are also shrinking) and financing costs.

Bottom Line

Back in May following the company’s first-quarter report — and a few times before that — yours truly here made the point that while a snapshot of JCPenney didn’t look particularly compelling, it’s not about where the company is that matters. It’s about where the company is going.

I’m not changing my tune. In fact, if anything I’m singing that tune louder now and suggesting emphatically that JCP stock is a buy simply based on the strength and plausibility of its turnaround effort.

To be fair, it’s still not a trade for the faint of heart, or the impatient. By my guess, it could be two to three years before JCPenney reaches a state of reliable profitability (if it ever does), and that assumes new CEO Marvin Harrison picks up right where Myron Ullman left off when Harrison took his place at the helm at the beginning of this month.

It’s a trade that also assumes JCPenney will become even more competitive in a tough retail environment made even tougher by online retailers. As was noted during the Q2 conference call, however, at the very least JCPenney understands retailing is an omnichannel affair now. Just recognizing this reality is a step in the right direction.

Whatever the case, with a price/sales ratio of only 0.2 versus the market average of 1.8, even the tiniest of profits in the foreseeable future would leave JCP stock well undervalued relative to its peers. The big “aha” moment for shares will most likely be when the market finally realizes a positive net income figure is in the cards.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

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