J.c. penney – many excuses, not many positive signs – j.c. penney company inc. (nyse jcp) seeking alpha hp gas online payment


I have recently analyzed the performance of department store operators in Q1 and wasn’t pleased with what I saw. Macy’s ( M) was the only player in the space that reported a solid quarter with an improving sales and comps trend, and a recovery in pricing power that helped margins. J.C. Penney ( JCP) was not so lucky.

According to the management, while February and March comps were ahead of the annual guidance range, April results were negatively impacted by unseasonable weather resulting in a sales comp increase of 0.2% for Q1. I am still surprised by how the weather is always too cold or too hot to do business. I don’t remember one quarter in the past 4-5 years when the management mentioned a favorable weather helping the business. Nonetheless, other department stores didn’t mention any particular problem, which makes me even more skeptical.

• Tourism and tourist spending are recovering thanks to a combination of positive conditions. First, concerns about terrorism are softening. Between 2014 and 2016, these concerns affected tourism in several western economies significantly, including the United States. Second, emerging markets are not in a recession anymore. While geopolitical tensions and economic sanctions continue to affect Russia, oil-driven economies are recovering thanks to the rising energy prices.

A 0.2% increase in comps is well below what we would expect in a rebounding retail space, and that’s not a surprise, considering that J.C. Penney’s main peers Macy’s and Dillard’s ( DDS) reported a much higher comps growth. Even Nordstrom (NYSE: JWN), which didn’t report a wonderful quarter, managed to grow comps by 0.6%, three times JCP’s growth rate.

Results were not exciting on the front of margins either. Gross margin in Q1 was 35.9% of sales, compared with 38% in Q1 2017, although the environment is much less promotional than it was last year or in 2016. JCP continues to lose pricing power despite the evident improvements in the industry.

The management said gross margin is a major focus for the company but so far we haven’t seen any meaningful improvements. Pricing power is clearly still a big problem for JCP, and there is an abundance of unfavorable trends that can make gross margin expansion difficult. One of them is the secular growth of eCommerce. As I pointed out in a few recent articles, eCommerce has higher variable costs compared to in-store retail (shipping, fulfillment, customer care, returns), and gross margins tend to decrease as a result of a higher percentage of sales moving online. J.C. Penney’s management expects cost of goods sold as a percentage of revenue to decline in the rest of the year, but we know how unreliable their guidance numbers are.

Not everything was bad. The company is still losing pricing power and facing margin-dilutive forces. On the other hand, there was a 270 basis points reduction in SG&A versus last year that confirms an improving control over corporate costs, but EBIT margin continued to contract due to the lower gross margin, confirming a negative trend restarted last year:

While the lower debt and interest expenses are two good signs for a company in J.C. Penney’s conditions, it’s clear that the company is still facing some important issues. I still have a skeptical view of JCP’s guidance after seeing how the actual results can be far from the management’s expectations. I focus on evidence and the evidence is that JCP is not being able to reverse the negative gross margin trend that has been affecting the company for a while, and comps are still anemic even during a period of strong rebound in the retail industry.

Growth in the beauty segment lead by Sephora. This is clearly a higher margin business with a stronger momentum compared with J.C. Penney’s core apparel retailing business. The division’s growth was not disclosed in detail, but the management said the business comped positively in Q1. Moreover, after opening 72 new Sephora locations in 2017 and adding 27 more this year, Sephora will operate in over 75% of JCP stores.

Growth in Salon. Like with the Sephora business, we don’t have detail on sales and margins in this division in Q1, but the management said the segment’s comps were positive. The management also mentioned a plan to rebrand and remodel another 100 salons to Salon by InStyle in 2018, a measure that usually generates a 400bps improvement in sales on average. I like the Salon business even more than the Sephora business, as it doesn’t face unfavorable secular trends nor competition from eCommerce players.

Growth in Furniture and Mattresses. This business had positive comps as well. The management said the company is gaining market share at the expense of Sears ( SHLD) and that its stores near Sears stores are showing an above-average performance, which suggests the possibility to grow market share substantially in case of further store closures from Sears shops.

Margin growth depends on how much and how fast these three higher-margin businesses will grow, other conditions being equal. A potential problem is that these revenue and comps trends don’t seem to allow a significant operating leverage, and eCommerce’s secular growth may offset margin improvements generated in other areas of the business.

Based on the free cash flow guidance in the $200 – $300 million range, we could think the stock is dirt-cheap at roughly 3x full-year FCF per share. If we could believe the management’s guidance, we could start to think about buying JCP at these levels, but I see a series of problems. The first is that we have seen that the management is not very good at forecasting the business’ performance. The second problem is that, FCF or not, the performance is deteriorating on many fronts. Comps grew slightly while sales declined 4% and gross margin contracted 210bps. The positive comps growth may be just a result of market share gains from the existing stores generated by the numerous store closures and lower selling prices as a result of higher promotions. In the end, a buyer at these levels is still buying a business with deteriorating fundamentals which shows no signs of improvement despite several years of efforts to trigger a turnaround. There are definitely much more attractive bets in the retail space.

Kenra Investors uses a unique combination of deep fundamental research and alternative datasets to generate market-beating returns in the stock market. If you want to access Kenra Investors’ best long and short ideas in the consumer and tech sectors, please consider joining Consumer Alpha . A 2-week free trial is currently available.