Is J.C. Penney's Turnaround A Pipe Dream?

| About: J.C. Penney (JCP)


The recent credit facility is nothing to get excited about as J.C. Penney is digging its own grave by increasing the debt.

Penney is burning through cash and its business structure is unsustainable.

Penney's stores are still unattractive and this will restrict sales growth.

The company is horribly leveraged and a turnaround doesn't look likely.

In the last one year, shares of retailer J.C. Penney (NYSE:JCP) are down around 46%. However, the company has given a ray of hope to investors with its turnaround strategies and strong results earlier this year. However, whether Penney will be able to sustain the turnaround or not is still questionable. Let's take a closer look at the company's moves and recent results, and see why it might be a risky turnaround play.

Digging its own grave?

Last month, it was reported that J.C. Penney closed on a new $2.35 billion asset-based senior secured credit line which has a cheaper borrowing rate. ValueWalk reported:

"According to the struggling century-old retailer, it closed a new $2.35 billion asset-based senior secured credit facility consisting of a $1.85 billion revolving credit line and $500 million term loan. J.C. Penney Company, Inc. (NYSE:JCP) said it will use the revolving credit for general corporate purposes and working capital. It will also use the proceeds from the loan to pay down its cash borrowings from the previous credit facility.

The retailer said the $2.35 billion senior credit facility provides better pricing terms and will replace the $1.85 billion facility, which is scheduled to mature in April 2016."

So, basically J.C. Penney has taken a loan to pay-off another loan and the company's management is trying to convince everyone that is a good move because of the lower "borrowing rates". As of now, Penney's total debt stands at almost $5.6 billion. This means that under the leadership of Myron Ullman, Penney has now borrowed over $3 billion from its credit line.

Increasing debt is never a good thing for horribly leveraged companies like J.C. Penney. The company is burning through cash at a rapid pace and is digging itself a grave by enlarging its debt. Penney's losses aren't expected to stop anytime soon, which is why investors shouldn't be excited about this event.

What next?

The company has re-launched its new home store, named Home Collections of J.C Penney. The aim is to re-merchandize the floor to make better use of the space and to confirm the way the customer wants to shop. The company is also focused on bedding, small electrics, as well as decorative accessories. It now offers a variety of home merchandise that are customer friendly meeting their budget and lifestyle needs.

The company opened 30 new Sephora inside J.C. Penney locations, taking the number of total stores to 476 and will open 13 more this month. It also expanded its eight outperforming existing stores to increase its footprint inside the store, while its Sephora stores continue to perform well.

Although same-store sales increased 6.2% last quarter, this increase is from depressed levels. However, this is a relatively better performance as same-store sales declined 16.6% and 18.9% in the first quarter of 2013 and 2012, respectively. But, store traffic was down during the quarter as compared to last year, which affects the same-store sales growth. With single digit growth in same-store sales, the cost structure of J.C. Penney is still unsustainable.


Even if the company somehow manages to get its gross margin back to better levels, its operating expenses as a percentage of revenue are so high that it will still deliver operating losses. Even it cannot do much cost cutting without closing stores. Hence, the company is left with only one option to prevent it from going bankrupt, which is to grow its revenue.

To grow revenue, store traffic needs to rise again. Although the company accomplished a sequential customer traffic increase last quarter, this seems to be just a drop in the ocean. The company has lost $2.5 billion over the past three years, and it again suffered a net loss of $352 million, last quarter.

J.C. Penney has fallen way too far behind competitors like Macy's (NYSE:M). The mall department stores are already facing stiff competition, struck by competition from specialty retailers and online-only players. Though margins increased in the last quarter, losses are still substantial. The debt that J.C. Penney took has increased its liabilities from $7.5 billion to $8.5 billion from a year earlier, which is a huge 14% increase.

The company has been in losses since the past 8 years, with the annual losses during the last two years amounting to over one-third of shareholder equity.

Not yet attractive

Much of J.C. Penney's failure can be attributed to the company's stores being unattractive. Toward the end of 2013, Brian Sozzi, chief equities strategist at Belus Capital Advisors, visited some J.C. Penney stores and highlighted this problem. The disorganization within the store was vividly visible and this has been a major problem for Penney. Sozzi said,

"JC Penney's shops were constructed in a manner that reduces the amount of goods available for sale on the floor. This is a major structural issue. There is no consistency, rather an array of facelifts on display in the store that reflect failed attempts to revitalize a business that operates in a super competitive, low margin arena"

Not much has changed since, which makes J.C. Penney's turnaround story less believable. So, investors should take Penney's turnaround with a grain of salt as the company is still not out of the woods.

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.

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