J.C. Penney (JCP) is soaring in trading Thursday. The stock rose over 4% in normal trading and over 3% in after-hours trading. The boost came after the company reported earnings Thursday, posting improvement for its third quarter in a row after nine straight declining quarters - but don't be fooled. The market may be encouraged but J.C. Penney is one stock you need to sell.
J.C. Penney may have seen some solid gains Thursday but that is really just more reason to sell. The company's share price has lost significant ground over the past three years and there is no cause to think that aspect will change. J.C. Penney's improvement in its bottom line and small increase in same store sales quarter over quarter does not change the fact that the company is grossly in debt. Over time, its weaknesses will outweigh the strength in its recent performance. Investors would be better off selling out now while the share price is somewhat elevated and putting their money in a better place.
J.C. Penney surprised analysts on Thursday. The retail chain posted a loss of $172 million or 56 cents per share, topping the year-earlier loss of $586 million or $2.66 per share and beating analyst estimates of a $2.79 billion loss, or a per share loss of 93 cents.
"Same store sales increased 6.0% for the quarter. Online sales through jcp.com were $249 million for the quarter, up 16.7% versus the same period last year," according to the company's 8-K filing. "Women's and Men's apparel and accessories, Home and Fine Jewelry were the Company's top performing merchandise divisions in the quarter. Sephora inside J.C. Penney also continued its strong performance. Geographically, all regions delivered sales gains over the same period last year with the best performance in the southern and western regions of the country."
But it isn't all good news. J.C. Penney has some serious weaknesses.
"While investors are celebrating the fact that J.C. Penney's loss narrowed, FY 2015 still isn't looking good for the department store player," writes Investor Place. "In fact, excluding tax benefits, J.C. Penney is expected to be in the red through the end of FY 2016! To add insult to injury, the analyst community has been steadily revising their EPS estimates down over the past 90 days. Meanwhile, sales are estimated to grow in the low single-digits over the next two years."
In addition, the fundamentals aren't there. The company's debt to equity ratio is 2.03. That is significantly higher than others in its industry and an important indicator that the company may not be managing its finances well. In addition, J.C. Penney has a negative net income. That may be improving - the most recent quarter showed a loss of $172 million compared to the same quarter last year when the company posted a loss of $586 million - but that much debt with that much loss is never a good combination.
J.C. Penney posted a gross margin of 36% in the most recent quarter, which is lower than what would be desirable for such a company. Its industry average is 37% but that figure is skewed by low performers. Macy's (NYSE:M) for example has a gross margin of 40%.
In addition, despite the recent rally on J.C. Penney, the company is still down 26% over the past 52 weeks and almost 65% over the past 3 years.
"The company says that third-quarter gross margin will be in line with that of the second quarter, and that in the full year, we will see a significant improvement over 2013. Also, the company says that comparable sales will increase in the mid single-digit range, in line with what we've seen this quarter for broke the third quarter and the entirety of the year," says Bloomberg. "Free cash flow was $76 million, which is a $1.2 billion improvement from last year because it had negative free cash flow from last year. Cash burn continues to be a bit of a concern, but much less than it was. It is all relative. When you hit rock bottom, the only way you can go is up."
But that doesn't mean it is going to be clear skies for J.C. Penney going forward.
Sure, this quarter's results were encouraging but there are better places to put your money, especially considering the market. Monthly retail sales peaked in March at 1.5% and were flat in July. "The consumer has plateaued,'' says David Tawil, president of hedge fund Maglan Capital. "We should not expect considerable growth among retailers except for the standouts. We really need to see personal earnings and wage growth and a sense of comfort in the economy in order to make the next leg in consumer-driven spending." Tawil continued by saying that J.C. Penney is "no longer on life support. On the other hand, this is not about one quarter, but the next five to 10 years. You need to have a long-term strategy."
And I have to agree. J.C. Penney is weak on fundamentals and one good quarter doesn't change that fact, even if it is its third improving quarter in a row. Expecting a weak company to improve while knowing that the retail sector is flat isn't a good long term strategy. Put your money in stocks with stronger operations and better outlook.
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.