J.C. Penney - Weak Quarterly Results Offset By Comforting 2013 Outlook

| About: J.C. Penney (JCP)

Shares of J.C. Penney (JCP) ended the week on a strong note. Shares of the troubled retailer gained over 12% the last week after reporting its quarterly results.

Second Quarter Results

J.C. Penney reported second quarter revenues of $3.02 billion, down 22.6% compared to 2011. The company reported a GAAP net loss of $147 million, or $0.67 per share for the quarter. Last year the company reported a small profit of $0.07 per share. Excluding certain items, the loss came in at $0.50 per share. Analysts expected the company to report a $0.25 per share loss.

The company reported a comparable sales decline of 21.7%, which came in far below analysts expectations of 17.4%. Gross margins fell from 38.3% to 33.2%, as a result of lower sales and a $102 million markdown related to inventory. The inventory mark down impacted margins by 340 basis points. Selling, general and administrative expenses fell by $193 million. The company remains on track to reduce costs by $900 million per annum. The company took $159 million in restructuring and management transition charges in the second quarter. Sales on JCPenney.com fell 32.6% to $220 million as the company cut back on marketing investments heading into the "back-to-school" season.

CEO Ron Johnson commented on the results, "We have now completed the first six months of our transformation and while business continues to be softer than anticipated, we are confident the transformation of jcpenney is on track. The transition from a highly promotional business model to one based on everyday value will take time and we will stay the course. Our rock solid balance sheet will support the execution of our transformation and position us for growth beginning in 2013."


The company no longer expects to achieve its previously issued non-GAAP earnings guidance for 2012. The company expects to end the fiscal year with $1 billion of cash. Cash balances remain tight as a result of $800 million in capital expenditures. The company is investing in its transformation efforts, which requires significant investments. Furthermore the company will pay off $230 million of notes due in August.


J.C. Penney ended its second quarter with $888 million in cash and equivalents. The company operates with $3.15 billion in short and long term debt for a net debt position of roughly $2.2 billion. For the first six months of 2012, the company reported revenues of $6.17 billion. The company reported a net loss of $310 million for that period, or $1.42 per share. At this rate, the company is on track to report annual revenues of around $13-$14 billion on which the company is expected to lose around $500 million.

The market currently values J.C. Penney at $5.1 billion which values the firm at 0.4 times annual revenues. This valuation compares to a revenue multiple of 0.6 times for Macy's (M), 0.6 times for Kohls (KSS) and 0.1 times for Sears (SHLD).

Currently, the company has suspended paying dividends.

Investment Thesis

Shares of J.C. Penney have risen almost 20% from their lows of July. An improvement in the market sentiment and short-squeeze rallies pushed shares towards the $23-$24 level. Shares still trade with losses of 33% year to date.

Shares started 2012 on a strong note as investors applauded the move to name Ron Johnson as the new CEO of the company. Johnson, was the former boss of Apple's retail stores. His new pricing strategy for J.C. Penney, by removing coupons and price actions and introduce every-day-low-pricing, has proven disastrous, at least in the short term.

The poorly executed and communicated pricing and promotional plans, resulted in an unprecedented 18.9% same store sales decline in the first quarter. Customer defected en masse as the company got rid of their beloved coupons. J.C. Penney's marketing executive Michael Francis has already been ousted as a result. The decline in comparable sales accelerated to 21.7% in the second quarter.

In recent weeks the company made concessions to its pricing strategy and the traffic decline slowed down notably in recent weeks. Furthermore, Johnson boosted confidence by dismissing doubts that the company does not have sufficient financial resources to complete the turnaround. Investors also react favorably to his comments that the company is back on track to achieve positive and profitable revenue growth in 2013.

Investors outweigh the positive comments of Johnson regarding 2013 and improved traffic numbers in recent weeks, over the terrible operational performance during the second quarter. For now, investors give Johnson the benefit of the doubt in his attempt to revamp the century old retail chain.

If the company can make the turnaround and improve its operational performance, there is a lot of upside left in the shares. A key test in the short term will be the holiday season in a couple of months.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.