J.C. Penney Earnings Preview: Serious Growth Needed

| About: J.C. Penney (JCP)

Summary

J.C. Penney is set to report its second quarter earnings after market close on August 14.

There needs to be serious growth in both comparable store sales and gross margin to show that the turnaround is working.

A lack of acceleration in these areas could lead to liquidity issues down the road.

Retailer J.C. Penney (NYSE:JCP) is set to release its second quarter earnings results after market close on August 14. The company has been slowly clawing its way back from the dead, with two quarters of comparable store sales growth, but as I stated in a previous article, J.C. Penney still has a long way to go. J.C. Penney will need to report some stellar numbers to convince me that the company's turnaround efforts are truly making meaningful progress.

What analysts are expecting

The average analyst estimate for second quarter revenue is $2.78 billion, up 4.4% year-over-year. During the first quarter, J.C. Penney managed to grow revenue by about 6.1% on the back of 6.2% comparable store sales growth, and with management stating that the results improved in each month throughout the first quarter, 4.4% growth seems a little conservative. J.C. Penney guided for mid-single digit comparable store sales for the second quarter, so if there is any comparable store sales growth improvement sequentially, it may be minimal.

Analysts are expecting a big loss of $0.94 per share, a vast improvement over the $2.16 per share adjusted loss from the second quarter of 2013. That's still a loss of around $285 million, and analysts are expecting a full year loss of $2.79 per share, or about $850 million.

Two numbers to watch

J.C. Penney is still losing an awful lot of money, and while the company expects to have $2 billion in liquidity, including both cash and available credit, at the end of the fiscal year, continued losses like the one expected for fiscal 2014 will wipe out that liquidity within a few years. For J.C. Penney to have any chance of preventing this, the company needs to show meaningful increases in both comparable store sales and gross margin.

Because sales have plummeted so far since 2012, single digit comparable store sales growth isn't going to cut it. During the first quarter, J.C. Penney spent 41.9% of revenue on operating expenses, compared to value much closer to 30% over the past decade. The company has done a good job at cutting costs, but at this point, the only way forward is to grow sales.

In fiscal 2014, which ended in January, revenue came in at $11.86 billion. Just two years earlier, revenue was $17.26 billion. That's a 31.3% decline. At a 6% revenue growth rate, it would take roughly 6.5 years to erase that decline, and J.C. Penney's liquidity would likely dry up at that pace. Comparable store sales growth needs to accelerate into the double-digits for J.C. Penney to have any chance at mounting a comeback, and both the company's guidance and analyst estimates point to this not happening.

The second important number is gross margin. Along with double-digit comparable store sales growth, J.C. Penney also needs to bring its gross margin back to historical values. In fiscal 2014, gross margin fell to 29.4%, down from the high 30s earlier in the decade. Gross margin rose to 33.1% during the first quarter, and guidance calls for sequential improvement, but this is still well below the percentage of revenue going toward operating expenses.

The path forward

At this point, J.C. Penney simply needs to get customers to come back to its stores. The month of April was the first month where the company saw positive store traffic in 30 months, according to CEO Mike Ullman during the first quarter conference call, and we'll learn on August 14 whether store traffic continued to grow during the second quarter.

J.C. Penney has done a few things in an attempt to boost store traffic. First, the company has focused on its private brands that were eschewed under the previous management, like St. John's Bay, and during the first quarter, these brands outperformed. Private label merchandise tends to carry higher gross margins than national brands, and a continued shift in mix could drive gross margins higher.

J.C. Penney also launched its new home store within its stores, called Home Collections, with a focus on products that are more aligned with the typical J.C. Penney customer. Additional Sephora stores were also opened within J.C. Penney locations during the first quarter, bringing the total up to 476, and according to management, these stores are performing extremely well.

Conclusion

There's no doubt that J.C. Penney is taking reasonable steps, but the company is still in a race against time. Its situation is not nearly as precarious as it was last year, but both comparable store sales and gross margin need to grow rapidly in order avoid liquidity issues in the coming years. I'm not optimistic that J.C. Penney can pull it off, but extremely strong numbers for the second quarter could prove me wrong.

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