Seeking Alpha
Long/short equity
Profile| Send Message|
( followers)  

One thing that gets misrepresented in coverage about J.C. Penney (NYSE:JCP) is the nature of its turnaround. Taking a look at the year-over-year trends (-16.6% in Q1, -11.9% in Q2, -9.8% in August, -4.0% in September and +0.9% in October) leads people to believe that J.C. Penney is making rapid improvements. Projecting these trends out further makes it seem like J.C. Penney is going to reach double-digit positive same store sales very soon. After all, J.C Penney's year-over-year trends improved sequentially by over 7% last quarter. Another two quarters at that rate would put J.C. Penney at around +10%.

That's not what is actually happening though. In reality, J.C. Penney's sales bottomed out in Q4 FY2012, marginally improved at the start of FY2013 and have essentially been flat since. We explained this situation in an earlier article, and the newer Q3 FY2013 numbers from J.C. Penney appear to match perfectly with our prior interpretation.

This changes the narrative around J.C. Penney. The current bullish narrative appears to be that J.C. Penney got rid of the CEO who caused its sales to plunge and brought back the old CEO, who is undoing the damage. The results of these changes are seen in the rapidly improving year-over-year trends.

How does that narrative look when sales have been flat throughout FY2013 though? Bears have been accused of looking to the past too much and not being forward looking. However, it seems quite premature to look toward a rosier future when there has been zero improvement over the last nine months (including seven months with the CEO change).

Adjusting The Revenue Model

We had estimated that J.C. Penney's October same-store sales would be up +1.0% year-over-year. J.C. Penney announced that October actuals were +0.9%. Plugging that into our sales model (updated to account for an atypical Q3 sales distribution in 2012 as J.C. Penney's situation got worse as the quarter went on) results in projected Q3 revenues of $2.786 billion. This is based on a -4.59% change vs. last year and $7 million in impact from closed stores.

Month

% Chg Vs. 2012

% of Qtr Sales

Impact on Qtr Sales

August

-9.8%

35.7%

-3.50%

September

-4.0%

34.0%

-1.36%

October

0.9%

30.3%

0.27%

Total Quarter

-4.59%

Attempting A Simpler Explanation

Here's an attempt at a simpler example of how J.C. Penney's sales have been progressing after factoring out seasonality. J.C. Penney's sales declined continuously from around Q4 FY2011 until bottoming out in Q4 FY2012. Since then sales have been relatively stagnant quarter to quarter, with no progress being made between Q1 FY2013 and Q3 FY2013.

Although it appears that J.C. Penney's sales are improving rapidly based on year-over-year trends, the truth is that sales hit bottom in Q4 FY2012 and have struggled to improve since then. The seasonally adjusted sales of 67 in Q3 FY2013 are barely better than sales of 65 in Q4 FY2012 and the same as sales of 67 in Q1 FY2013.

Looking forward to Q4 FY2013, we can see that even stagnant sales of 67 will result in a +3% year-over-year gain. Such a result may cause J.C. Penney's stock to appreciate based on expectations for continued improvement in year-over-year trends. However, a spike based on that sort of news would appear to be an ideal time to take/increase a bearish position on J.C. Penney since it would actually indicate that J.C. Penney has not made any meaningful improvements in sales over an entire year.

Seasonally-adjusted sales for J.C. Penney. Q1 2011 = 100

Q1

Q2

Q3

Q4

2011

100

100

95

95

2012

80

77

70

65

2013

67

68

67

67

% Chg 2013 vs. 2012

-16%

-12%

-4%

3%

Strong Web Sales And Continued Weak In-Store Sales

Web sales have rebounded strongly to reach an estimated $265 million to $270 million in Q3 FY2013. However this is still down 26% from Q3 FY2010 and competitors have passed J.C. Penney during the last three years. For example Kohl's had web sales of $125.7 million in Q2 FY2010 versus $317 million for J.C. Penney. Kohl's has since increased its web sales by 141% to $303 million in Q2 FY2013 versus $215 million for J.C. Penney.

The 37.6% growth in web sales for J.C. Penney in October sounds very impressive, but is likely helped by terrible web sales in Q3 FY2012, which were down 37% from the year before while Kohl's was up 50% during the same quarter. Web sales growth for retailers should naturally be very high and are needed to help counteract continued declines in in-store sales.

Web Sales For J.C. Penney

($ Million)

Q1

Q2

Q3

Q4

2010

353

317

361

495

2011

376

326

341

480

2012

271

220

214

315

2013

NA

215

265-270

Below we have attempted to estimate what in-store and web sales were for J.C. Penney during Q3 FY2012 and Q3 FY2013. This was attempted based on management comments from Q3 FY2012 earnings transcripts and various press releases. In-store sales are still weak both in year-over-year trends and when looking at it sequentially.

Month

2012 Sales ($ Million)

2012 In-Store Sales ($ Million)

2012 Web Sales ($ Million)

2013 Sales ($ Million)

2013 In-Store Sales ($ Million)

2013 Web Sales ($ Million)

August

1045

969

76

941

857

84

September

995

922

73

952

860

92

October

887

822

65

893

804

89

Total Quarter

2927

2713

214

2786

2521

265

Are J.C. Penney's Stores Packed With People?

There are posts on the Internet of people doing store checks and mentioning how busy the J.C. Penney stores are. While this may be true of select stores, J.C. Penney's own information indicates that traffic for the company overall still hadn't meaningfully recovered by October.

In Q3 2011, J.C. Penney mentioned that mall traffic (which represents the majority of J.C. Penney's stores) was down 2.4%.

In Q3 2012, J.C. Penney indicated that traffic was down an additional 12%, with September/October traffic down around 14% or more.

The latest update mentioned that overall traffic in October fell below last year's levels. While J.C. Penney is starting to show some year-over-year improvements in conversion (getting people to buy things once they are in the store), it is still having serious difficulty attracting people to stores in the first place, as traffic alone appears to be down approximately 20% from 2010 levels.

What this means for Q4

As mentioned earlier, J.C. Penney should be able to report +3% same-store sales in Q4 FY2013 even if sales continue to be flat quarter-over-quarter. However, J.C. Penney will need to start showing actual true improvement in sales in FY2014 if it has any hope of meeting expectations for near double-digit same-store sales growth.

On the surface +3% year-over-year same-store sales may look solid and cause J.C. Penney's stock to go up. However, this would indicate a continuation of current flat trends, and sets the stage for severe disappointment in Q1 and beyond.

Conclusion

We find it hard to buy into the story of J.C. Penney's turnaround when sales have actually been flat throughout 2013. Traffic has continued to be very weak as well with no improvement in being able to attract customers to stores. At the very least, the sluggish pace of the turnaround indicates that J.C. Penney will likely burn through a tremendous amount of liquidity before it reaches break-even, resulting in a very high likelihood of dilution or additional debt.

J.C. Penney bulls appear to believe that getting back lost customers and reaching double-digit sales growth is an easy thing to do. However, losing customers is much easier than winning them back. Q3 sales and traffic levels do not appear to have improved at all from Q1.

We will remain bearish on J.C. Penney until it actually shows some true improvement in sales and manages to do so without sacrificing margins.

Source: J.C. Penney: Sluggish Pace Of Turnaround Continues, No Signs Of Improvement In Q3