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J.C. Penney’s (JCP) Battle to Profitability Continues

JCP is in the midst of a successful turnaround, but there's still work to be done

By Brian Wu, InvestorPlace Contributor

http://invstplc.com/1U6gC7Q

As the old seafaring saying goes, large ships take ages to turn. The same aphorism can be applied in business, as most investors knew it would take several years at the very least (as well as plenty of chutzpah and luck) to steer J.C. Penney (JCP) back on course.

JCPenneyLogoAfter the snafu of the Ron Johnson era that saw JCP lose as much as 25% of store traffic and 22% of same-store sales, the company found itself in the precarious position of enduring massive product markdowns in a bid to lure shoppers back to its stores and sell off its stale inventory.

J.C. Penney stock was pounded as a result, down more than 70% over the past couple of years.

J.C. Penney Is Improving Margins

In 2013, J.C. Penney’s gross margin dropped to a low of 23%, far from its historical norm north of 37%. But JCP is exhibiting signs of recovery as it inches closer to moving from the red to the black.

J.C. Penney finished the quarter with a gross margin of 37%, up 100 basis points year-on-year, the highest mark recorded by the company since former CEO Myron Ullman took over for a second tenure. The higher gross margin is also the closest JCP has come to its historical norm.

And J.C. Penney has seen sustained margin improvement for several quarters now, as it worked feverishly to get rid of the old overhang. JCP has also been introducing private labels, such as St. John’s Bay and Worthington, to boost store margins. Private labels tend to reel in better gross margins than their national brethren, and Mr. Ullman has pointed out that striking an optimal balance between national and private brands is tricky, since national brands are necessary to lure in customers through the door, yet private brands are where the real money is.

JCP’s willingness to test new brands and concepts has especially aided in the store’s turnaround. J.C. Penney has been riding Walt Disney’s coattails through the J.C. Penney’s Disney Shops, a part of the store-within-a-store concept championed by Ron Johnson. The Disney partnership has been a remarkable success, with JCP CFO, Ed Record, terming it ‘‘a home run’’ for the kid’s department. JCP plans to open 116 new Disney Shops during the current year, which would bring the total to 680.

Investors can only hope that new CEO Marvin Ellison builds on Ullman’s progress, or even one-ups his predecessor by introducing novel ideas of his own.

JCP’s Improved Profitability

J.C. Penney’s improved gross margins have trickled right to its bottom line. JCP’s net loss of $138 million for the quarter clocked in at a mere 1.3% of net sales, compared to 2.3% of sales during the prior year period. Operating income improved 120 basis points to a loss of 1.3%, which was helped by a 310 basis point contraction in selling, general and administrative expenses to 31.3% of sales.

The company’s Q2 same-store growth of 4.1% was high enough to suggest that the retailer stole some market share from slower-growing rivals such as Macy’s (M) and Kohl’s (KSS), neither of which has touched the 4% growth mark for the last 10 quarters running.

To be fair, JCP’s numbers received an artificial boost by the lower hurdle it had to cross courtesy of the double-digit quarterly comp declines it recorded for two years running during the time of Ron Johnson. But it’s still hard to deny the fact that the current growth streak is the longest the company has enjoyed in several years.

Is JCP Stock a Good Buy?

J.C. Penney has surprised many of its naysayers by coming this far, when most detractors repeatedly squawked that it was just a matter of time before its high cash burn rate finally brought the company to its knees. But J.C. Penney’s cash flow, while not exactly in the pinkest of health, has seen marked improvement, with the company recording positive free cash flow during the last quarter.

Surprisingly, JCP stock has been selling off over the past week as investors seem unable to make up their minds whether this is just the calm before the storm.

JCP has been lucky to have a brilliant CEO in the form of Ullman at the helm during the most critical stage of the turnaround, without whom many observers feel that J.C. Penney would probably have become another retail also-ran. The company has beat expectations for six out of the last seven quarters now, with two of those coming during the most recent quarters. That’s a far cry from seven straight misses it racked up before that.

But it might still be a bit preposterous to claim JCP stock is now home and dry. The company’s comps still remain well below their 2011 mark, and there is still work to be done before J.C. Penney can fully reclaim its former status as a world class retailer.

But for bold contrarian investors, JCP stock is probably as good a turnaround bet as they come. With a price-to-sales ratio of 0.2 vs. 1.8 for the industry, JCP just needs to continue its northbound profit momentum before the scales begin to tip JCP stock’s favor.

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

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Article printed from InvestorPlace Media, https://investorplace.com/2015/08/jcp-stock-jc-penney/.

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