Don’t Buy the J C Penney Company Inc Stock Rally

Big sales numbers don't change the depressed narrative for JCP

By Luke Lango, InvestorPlace Contributor
For J C Penney Co. Inc. (JCP) Stock Survival is the Victory

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In late October, department store giant J C Penney Company Inc (NYSE:JCP) provided really ugly preliminary third-quarter numbers while significantly cutting its fiscal 2017 guide. JCP stock sold off big time from $3.50 to a low of $2.40 in a hurry.

Now, JCP has delivered third quarter numbers that are well above those prelim numbers the company gave just two weeks ago. Comparable sales rose 1.7% when management said they were going to rise just 0.7%. JCP stock is bouncing back to just over $3.

But there are a few catches.

One, the depressed full-year earnings guide didn’t change. Two, the positive sales performance is being driven almost entirely by heavy discounting, which is unsustainable. Three, there’s still $4 billion in long-term debt on the balance sheet.

Four, the bounce means JCP stock now trades at more than 60-times this year’s earnings. And five, sales are still moving online in a hurry.

All in all, I’m not biting on this JCP stock rally. I think its just a head-fake in a long-term down-and-out trajectory.

JCP Is Driving Sales Through Heavy Promotions

On the surface, the JCP numbers look pretty good. Comparable sales rose 1.7%, on top of a 0.8% decrease last year, so the 2-year stack is actually up 0.9%.

That is better than the 2-year stack comp at Macy’s Inc (NYSE:M) and Kohl’s Corporation (NYSE:KSS), but slightly worse than the 2-year stack comp at Nordstrom, Inc. (NYSE:JWN). In other words, in terms of comparable sales performance, JCP is the near the top of the department store industry.

But this strong sales performance is due mainly to one thing: heavy discounting. Gross margins at M, KSS, and JWN are largely flat year-over-year and stable with 2015 levels. But gross margins at JCP fell 320 basis points last quarter on top of a 10 basis point decline one year ago.

This isn’t a one-time thing, either. Gross margins fell 200 basis points last quarter.

When gross margins were stable (up 10 basis points in Q1), comparable sales were tanking (down 3.5%).

In other words, JCP can’t drive traffic unless it runs heavy promotions. That is especially troubling because other department stores are starting to drive positive comparable sales growth while preserving gross margins. That makes JCP stick out like an eyesore.

Moreover, the current retail backdrop won’t change anytime soon. In fact, it might just get more promotional as more sales go online and free shipping plus quick delivery becomes a standard. Because of this, it looks like the only way JCP will drive traffic into the foreseeable future is through heavy promotions.

Just look at the how the guide has changed. Yes, comparable sales are now expected to be positive (versus flat at the beginning of the year). But earnings per share are expected to be just 5 cents (versus more than 50 cents) due to a big shift in the gross margin guide (up 30 basis points to down 110 basis points).

Driving sales through heavy promotions is a tough place to be because earnings are already sitting at a narrowly positive 5-cents-per-share. Any more promotions and you risk turning that narrow profit into a loss. A company that loses money with a ton of debt is a recipe for a disaster.

Bottom Line on JCP Stock

This is just a dead-cat bounce because the headline Q3 comp number impressed the Street.

But the fundamental narrative remains little changed. JCP is using heavy promotions to drive sales, and has not shown an ability to drive sales without compromising gross margins. That is a dangerous place to be when earnings are narrowly positive and debt is more than 16x as big as this year’s projected free cash flow.

In the long-term, today’s big jump will look just like a head-fake in an otherwise down-and-out trajectory for JCP stock.

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

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