Is J.C. Penney Hiding Something?

Dec.25.13 | About: J.C. Penney (JCP)

The increase in J.C. Penney's (NYSE:JCP) November same-store sales didn't surprise me. The company's management has always been eager to convince investors that Penney's is close to executing a turnaround, so I knew that there was something suspicious behind the increase in sales. The uptick in sales has misguided many investors into believing that the retailer is on track for a turnaround, but it may not be the case. Let's take a look why.

Meaningless increase in sales

J.C. Penney issued a press release regarding November sales on December 3. It claimed that same-store sales for the month of November had jumped 10.1%. This may seem impressive at first, especially if you take into account the fact that this year, November ended just one day after Black Friday as compared to last year when there were seven more days for shopping. However, this isn't as impressive as it seems for many reasons.

Firstly, like many struggling retailers, J.C. Penney adds up its online store sales to its same-store sales, which doesn't paint the true picture behind the increment in sales.

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

1,045

969

76

941

857

84

September

995

922

73

952

860

92

October

887

822

65

893

804

89

Total Quarter

2,927

2,713

214

2,786

2,521

265

Click to enlarge

In the October report, J.C. Penney claimed that same-store sales had increased 0.9% sequentially. But if you look at the table above, you will come to know that in-store sales went down, but the increase in low margin online sales compensated for it.

Secondly, hurricane Sandy had a negative influence on sales in November 2012, thus the bar was already set so low that it was easy for J.C. Penney to beat it.

And lastly, the company's sales suffered last year because it decided to open stores at 6 am on Black Friday, while its peers opened at midnight. Since J.C. Penney adds up its online store sales to in-store sales, its overall increase in same-store sales is meaningless.

Decreasing margins

In the month of October, J.C. Penney's CEO, Mark Ullman, made the sequential 0.9% increase in same-store sales look like a massive achievement by saying:

We are proud of our October sales improvement, which we achieved despite the federal government shutdown and a challenging consumer environment.

However, he didn't reveal the fact that sales moved north primarily because of the intense discounting and couponing which came at the cost of profit. This misleadingly convinced investors into believing that the retailer is on the right track and as a result, J.C. Penney's shares started surging.

Moving on to November, the company didn't mention about the gross margin in the recent press release. This is suspicious, and I believe it is highly likely that the increase in November sales was at the expense of margins. It will not be astonishing if J.C. Penney's gross margin dropped below October levels. Declining gross margins don't mean that the company is close to engineering a reversal of fortunes, especially if you consider the fact that J.C. Penney is trying to recover $4.3 billion in lost sales. This fact was clarified back in November when J.C. Penney released its quarterly report and missed on both revenue and earnings targets.

Declining traffic

In October, J.C. Penney stated that it had witnessed a favorable customer response to promotional events and improved inventory levels, but its overall traffic declined. Although the company did manage to sugarcoat the traffic decline by stating that the average customer is spending more, it is very unlikely. J.C. Penney did not release traffic data in its November update, and this further indicates that the increase was driven by low margin online sales. Moreover, given that J.C. Penney's traffic has declined nearly 20% in the last three years, it is quite probable that it went down in November as well.

Conclusion

Hence, investors shouldn't buy J.C. Penney's turnaround just yet, as there is certainly more than what meets the eye. The company didn't release complete details, and if it is relying on low-margin items to drive sales, it means that the turnaround is just superficial as earnings are not increasing. So, investors should not buy the stock even though November same-store sales increased as the business still remains weak.

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.