Friday, May 17, 2013

Post Earnings J.C. Penney: The Good And The Very Ugly

J.C. Penney's (JCP) stock price was down 0.95% Thursday, but after-hours movements show an improvement in downward momentum: -1.7% so far. This indicates that investors have mixed feelings about the earnings call, which occurred Thursday one hour after the close. In this article, we provide a quick overview of JCP's main weaknesses. Then, we move to the core of our article: an overview of the earnings call. We finish the article with our traditional final remarks.

JCP Chart

J.C. Penney's 101: A quick introduction to the stock

JCP has a well-known problem: the firm is unable to stop losing out to both "higher-end merchants" and discount stores. So it is not surprising to see the one year poor performance of the stock compared with its main rivals: Macy's (M), Target (TGT) and Wal-Mart (WMT). Price movements are a clear reflection of JCP's poor results: sales were down 25% in 2012, same store sales down 25% and an increasingly worrying cash burn trend. The reasons for poor sales performance are manifold, but I think it is important to realize that the firm was addressing neither the upper class nor the lower class (in terms of income) of the national market.

They target young customers who belong to the middle class. They also happen to be more price sensitive than before, especially after the big recession in 2008. This was an excellent expansion opportunity for competitors like Target and Wal-Mart, who became more attractive due to deep-discounts and other promotions that they could not find at JCP. As a result, sales performance had to pay the consequences of this erroneous marketing strategy. Just in 2012, the company saw $4 billion in lost sales.

The company showed some preliminary first-quarter sales and balance-sheet figures last week (May 8th) that did not look so promising: sales figures showed a decline of 16.4%, or 16.6! % on a same store basis, to $2.64 billion. The upside is that by showing some of the results first, the company may have succeeded in lessening the shock value of Thursday's official earnings, at least for the time being.

Earnings Overview: The Good

- By providing a pre-earnings call on May 8th, JCP apparently managed to lessen the effect of some terrible news.

- So far the company has drawn down $850M on its $1.85B committed revolver. Therefore, the risk that the company draws on its revolver for the first time in its history remains very low for this year. That being said, if the company continues burning cash, expect the default probability to increase. Notice that the revolver is secured and the current debt isn't.

- It could have been worse! Total sales for the quarter decreased 16.4% to $2,635 million compared to $3,152 million in the same quarter last year. Since in 2012Q1 the company saw its revenue decrease -18.9% q/q, a 16.4% decrease shows that at least the negative acceleration of sales growth is decreasing.

Earnings Overview: The Very Ugly

- Worse than expected results: Excluding charges related to restructuring and the management transition, Penney lost $289 million, or $1.31 per share. The street had expected an adjusted loss of $1.06 per share on revenue of $2.65 billion, according to research firm FactSet.

- JCP is trying to make sales better by introducing more discounts and promotions but this is having a fast and clear negative effect on margins. In the words of Ken Hannah, current CFO:

Our reported gross margin rate for the quarter was 30.8% compared to 37.6% in the first quarter last year. The 680 basis point reduction year-over-year was driven primarily by higher penetration of clearance merchandise sales. Reported gross margin for the quarter was up 700 basis points sequentially from the fourth 2012 on lower clearance penetration.

- There is no clear and consistent strategy for a relaunch of, which lost significant sal! es volume! in 2012. As customers continue migrating to Macy's or Amazon (AMZN), we would like to see a clear online strategy for improving sales. In the words of Mike Ullman, current CEO:

Over the last year functioned as a completely separate entity inside the company with little synergy between stores and online. We need to create a seamless all channel experience with strong store and digital convergence.

- No growth: The following key metrics continue to be in deep trouble: Comparable store sales decreased 16.6% for the previous quarter. Traffic was down 6%. Store conversion was down 1% and average transaction value was down close to 10%.

- Some stores will be closed:

We are going to sell a specific number of shops, it will test and build out the ones that customers clearly want.

Final Remarks

Price target:15.00 / from N.A.
Rating:Sell / from N.A.
Investment Strategy:Event
Investment Horizon:3 - 6 months
Links: SEC Filings

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

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