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Summary

  • J.C. Penney has a huge debt burden and its cash position is weak.
  • Penney needs to make continuous improvements in its bottom line to stay afloat.
  • Penney seems to be making the right moves, and its recent performance suggests that the turnaround strategy is working.
  • Closure of underperforming stores and the addition of private-label brands should assist Penney’s long-term growth.

Shares of beleaguered retailer J.C.Penney (NYSE:JCP) have gained a massive 58% since the company posted its fourth quarter results on Feb. 26. The optimism around Penney's shares was driven by the fact that the company posted a lower than expected loss of $0.68 a share as against the $0.85 forecast by analysts. In addition, Penney reported its first quarterly sales gain since the second quarter of 2011. However, the question whether Penney can sustain this remarkable run is a difficult one.

A few concerns

While management is working hard to reinstate J.C. Penney to its former glory, the balance sheet has something else to say. Penney has a debt of $5.6 billion on its balance sheet while it has cash of just $1.52 billion. In addition, Penney's cash flow from operations is negative. So, while it was a good thing that Penney's loss was less than expected in the previous quarter, the company now has to ensure that it keeps improving to avoid going under.

Also, the holiday season helped Penney improve its sales and profit margins, led by the home department, men's apparel, women's accessories, and Sephora. But it remains to be seen if the company can sustain such a performance going forward when there is no holiday season around.

Good progress so far

Penney's turnaround strategy has worked well so far, but it has a long way to go as it competes with mammoth stores such as Macy's (NYSE:M) and online retailers such as Amazon (NASDAQ:AMZN). But, the impressive thing about Penney is that it is working well on a turnaround strategy, which it has split into three phases.

Penney focused on immediate stabilization in the first phase, followed by a rebuilding phase, and now the go forward phase. The first two phases have been completed over the last 10 months, and the retailer is currently focusing on the go forward phase.

Penney has strengthened its relationship with domestic and international suppliers by sharing its turnaround policies with them. This has brought more clarity within the company as well as with its suppliers. The company has also focused on its merchandising and marketing strategies, which have helped it in reconnecting with its core customers.

Keeping these strategies in mind, Penney will be investing in inventory at specific time periods such as before the reopening of schools and ahead of the holiday season to meet the anticipated customer demand. The company has brought popular private brands as required by customers to its locations while clearing out unproductive inventory. Penney has also improved the online experience of its customers by merchandizing assortments and restoring inventory levels.

In the third phase of its turnaround, Penney will see some negative impact on its margins as it has closed several brands, which were not a part of this phase. It has also right-sized some of its brands, such as Joe Fresh, Michael Graves Design, Conran, and some other brands in the home segment. But, since the margins had already taken a hit in the fourth quarter, management does not anticipate a negative impact in 2014.

Making the right moves

One of Penney's long-term goals is to increase its assortments, so the company will bring back important private brands such as St. John's Bay, A.N.A., Ambrielle, and Xersion to its locations. The company believes that customers have a strong connection with these brands, and these should also help the margins improve. Penney will also refocus on bedding and bath, small electrics, decorative accessories, and home furnishings, which will fit its customers' budget and lifestyle.

Also, the company is planning to close around 33 underperforming stores, which it expects to complete by May this year. On the other hand, Penney has plans to open a new store at Brooklyn, New York. It plans to open 46 new Sephora stores inside J.C. Penney, which will bring the total number of Sephora locations at J.C. Penney to 492 by the year-end.

Looking forward, management is positive about its performance considering the tough situation prevailing in the retail environment. It expects the gross margin to improve in the first quarter of 2014, as well as for the full year. In the words of CEO Mike Ullman:

The long-term goal is to return to historical gross margins and silly grow our sales volume to regain market share, leverage expenses and return to profitable growth.

Although this will take some time, Penney has realistic plans in place and hopes that it will once again lead the American retail industry.

Conclusion

At present, Penney does not have a trailing P/E or a forward P/E since it is incurring a loss. But, based on its performance in the fourth quarter, we can assume that the company is making a turnaround. Two years back, the stock was trading at $35, but since then, it has continually fallen.

After hitting a 52 week low of $5 just a few weeks ago, Penney is back on track, and investors are showing their interest in it. Looking forward, management is positive about the company's prospects and has various plans lined up for this year. Considering these factors, J.C. Penney looks set to continue the turnaround.

Source: J.C. Penney: Will The Turnaround Continue?