Is JC Penney now a sexy growth retailer? Well, a casual investor would fancy that the company is about to enter beast mode, taking down the likes of Macy's and Kohl's this holiday season with eye-popping promotions displayed on plastic displays on quality private label brands, and better national brands. If you believe that, I can get you in on the next hot IPO, Square, for a penny — all you have to do is send me a $100,000 check, today!
Although JC Penney continues to stress trends in sales and margins are heading in the right direction, there is a teensy overlooked aspect to the newly formed bull view on the stock: Color on profits are completely MIA, as are further confidence-inspiring comments on the third-quarter cash burn rate. Pardon me for having a rational analyst moment, but receiving factual numbers on the topic of the bottom line and connected cash flow statement are necessary to think that JC Penney will be a former "Dog of the Market" in 2014.
In the meantime, it's plainly obvious that gross margin is still under intense pressure from two aspects: (1) reduced margins on clearance merchandise to move aging inventory; and (2) increased promotional events to drive traffic. These are the two elements that are driving the epic sales rebound, therefore hindering profit potential and the amount of cash the business is able to produce.
In understanding JC Penney, at this point in time, you really need to do some analytical stalking. Here is how to get the job done so you are not left holding the bag on one of the worst-performing stocks in 2013.
Step No. 1: Stalk comments made by JCPenney
From the October 2013 sales press release
- Overall, gross margin for the third quarter was negatively impacted by lower clearance margins due to the overhang of inventory from the first two quarters of the year, higher levels of clearance units sold, as well as the company's transition back to a promotional pricing strategy.
- The company reported that, while average unit retail and overall traffic fell below last year's levels, the average transaction value and units per transaction in October were up from last year.
From the September 2013 sales press release
- Gross margins continue to be impacted by lower clearance margins due to the overhang of inventory from the first two quarters of the year, higher levels of clearance units sold during the period, as well as the company's transition back to a promotional pricing strategy during the second quarter of 2013.
- The company's year-end liquidity is now expected to be in excess of $2 billion. (Note: This was not mentioned on the October sales release).
- Traffic trends have improved during the quarter, including positive off-mall traffic for the last two weeks of September, though traffic in the company's mall-based stores continues to be difficult. (Traffic declined in October.)
Takeaway: JC Penney has thrown three sheets to the wind to regain sales momentum (yet sales are still lagging rivals) and when push comes to shove, increased promotions are not even triggering consistent sales gains month to month.
Step No. 2: Know the facts that impact the future
- JC Penney's merchandise margin has settled into a new 29 percent to 31 percent range (department stores usually in range of 37 percent to 39 percent), light years below the 2009 peak cycle performance of 39.4 percent. In plain English, this means the company will have to drive more people through its doors, each month (not just during holidays), to profitably run the business longer term.
- Macy's is aggressively remodeling its stores, in many respects creating the "Middle America Department Store of the Future."
- JC Penney's second floor shops were constructed in a manner that reduces the amount of goods available for sale on the floor. This is a major structural issue that can only be fixed by bulldozing Ron John's shops (which is not being done).
- JC Penney is basically two companies: 500 remodeled stores and 500 un-remodeled stores (aka "zombie stores"), so consumers are seeing two different and confusing views of the brand. For JC Penney to survive, it must get out of some really bad stores where it no longer makes sense to exist.
- Under its newly expanded, $2.25 billion credit agreement, outstanding balances have to be repaid by April 4, 2014.
What's in stores
A key to getting the truth on any retailer (which is not always reflected in the stock price) is to visit stores, tons of them. Here's what we've learned from in-store visits.
Furniture is not moving. JCPenney still has an excess of flashy, overpriced furniture collecting dust on its sales floors. Despite some discounting on it, the market is not letting them clear the goods as to raise cash.
My view is that deeper promotions are needed on these goods — and fast.
Unproductive space. A department store makes money because it offers racks upon racks of merchandise at discounted prices. JC Penney still has home departments that are wasting space to show an experience to the consumer.
There's a lot of wide open space where where racks of discounted merchandise could be that would lead to cash being put in the register. The kitchen departments are especially lacking in terms of productivity — relics of a very flawed strategy.
— By Brian Sozzi
Brian Sozzi is CEO and chief equities strategist of Belus Capital Advisors. Follow him on Twitter @BrianSozzi.
Disclosure: Neither Brian Sozzi nor Belus Capital Advisors own shares of JCPenney or other stocks mentioned here. Belus has had a "sell" rating on JCP since Jan. 2012. The price target was removed a month ago.