J.C. Penney: Examining The Q3 Earnings Report

Nov.20.13 | About: J.C. Penney (JCP)

J.C. Penney's (NYSE:JCP) Q3 FY2013 earnings report was just released today and we are going to go through some of the preliminary positive and negative takeaways from it. We are also going to go over the accuracy of our Q3 estimates. Most of these estimates were quite accurate although greatly aided by the volume of information that J.C. Penney provided during its progress updates.

Results Versus Our Projections

Here are the Q3 results versus our projections that were outlined in previous articles.

  • Q3 Revenues of $2.779 billion versus our projection for $2.786 billion.
  • Web sales of $266 million versus our projection for $265 million.
  • Same store sales growth of -4.8% versus our projection for -4.59%.
  • Gross margin of 29.5% versus our projection for 30.0%.
  • SG&A of $1.006 billion versus our projection for $1.05 billion.
  • Interest expense of $99 million versus our projection for $100 million.
  • Net loss of $489 million versus our projection for a net loss of $491 million.

Although certain items (most notably SG&A) were off by a bit, overall the projections were quite accurate. As noted in the introduction, a careful reading of J.C. Penney's comments plus SEC filings would provide most of the information needed to make an accurate projection.

Positives For J.C. Penney

J.C. Penney appears to be making significant progress on SG&A expenses. FY 2014 SG&A appears likely to be in the $4.0 billion to $4.2 billion range now, with Q4 FY2013 coming in at around $1.1 billion to $1.15 billion. This is down from $4.5 billion in 2012 and $5.1 billion in 2011.

Gross margins are rebounding quickly. The comments about sequential improvement in gross margins and promotional mixes comparable to 2011 levels would imply Q4 gross margins of 30%-31%. This is a marked improvement on Q4 FY2012's 24% gross margins. From management's comments, it appears possible that J.C. Penney will reach historical gross margin levels around 1-2 quarters earlier than we expected.

Q4 FY2013 may be the first time that J.C. Penney has gross margin that exceeds SG&A since Q1 FY2012. Although this is likely to turn negative again in Q1 FY2014, this is a major improvement over last year's disastrous Q4.

The situation of a liquidity crunch is off the table for at least a couple quarters, although that was never a realistic threat for Q4 FY2013 after the stock offering.

Negatives For J.C. Penney

There is still no definite sign of improvement in sales. Same store sales fell by more in Q3 than expected based on the monthly year-over-year change numbers that J.C. Penney had provided. That means that October 2012 represented around 29.1% of Q3 FY2012 sales, versus a historical average of approximately 32%. This means that October 2013 represented about 30.7% of Q3 FY2013 sales, indicating that seasonally-adjusted sales likely got sequentially worse during the quarter.

% Chg Vs. 2012

Estimated
2012 - % of Qtr Sales

Impact on Qtr Sales

Estimated 2013 - % of Quarter Sales

August

-9.84%

36.90%

-3.63%

35.00%

September

-4.04%

34.00%

-1.37%

34.30%

October

0.86%

29.10%

0.25%

30.70%

Total Quarter

-4.75%

Click to enlarge

Positive traffic for November was expected due to the effect of Hurricane Sandy in 2012 and generally poor traffic numbers in Q4 FY2012. Positive guidance for same-store sales in Q4 was also expected since even flat sequential sales (based on historical patterns) would result in a roughly +3% increase in year-over-year sales as mentioned in a previous article. So far, there hasn't been any information that indicates that J.C. Penney has been able to improve its sales after adjusting for historical patterns.

While it appears at first glance that a projection of $2 billion in year-end liquidity is positive, that projection still allows for a large loss. We would be more impressed if J.C. Penney had raised its liquidity projection back to $2.2 billion based on its August projection for $1.5 billion in year-end liquidity plus the capital raise.

As it stands, with $1.71 billion in liquidity at the end of Q3, it will only need to increase liquidity by $290 million to reach the $2 billion projection. This should be quite easy to accomplish with the normal inventory drawdown in Q4. J.C. Penney increased liquidity by over $400 million in Q4 FY2012 despite a brutal quarter.

Conclusion

The main positive news from J.C. Penney appears to be significant reductions in SG&A as well as gross margins that appear to be rapidly improving toward historical levels. The main negative news from J.C. Penney appears to be continuing flat traffic and seasonally-adjusted sales levels, as well as no positive guidance on those fronts beyond being able to beat very easy 2012 comps.

As it stands, the main bull and bear theses both remain intact. It remains to be seen whether J.C. Penney can improve its business quickly enough to avoid another round of dilution or a debt raise in Q2 or Q3 FY2014. The only things off the table at this point are the more extreme positions such as a Q4 FY2013 bankruptcy, which was never realistically going to happen.

In a future article, we will update the J.C. Penney model to reflect the new information gained from this earnings report.

Disclosure: I am short JCP. 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.