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Don’t Be Fooled. The J C Penney Turnaround Isn’t Here Yet

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Luke Lango
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Shares of J C Penney (NYSE:JCP) soared on Thursday, after the department store retailer reported fourth-quarter numbers that were above expectations everywhere it counts. Revenues topped expectations. Same-store sales fell by less than anticipated. Earnings came in nearly double the consensus Street estimate. In response, beaten up JCP stock rose as much as 31% before settling.

For J C Penney Co. Inc. (JCP) Stock Survival is the Victory
For J C Penney Co. Inc. (JCP) Stock Survival is the Victory

Source: Shutterstock As of this writing, JCP is up 18.5% from pre-earnings prices.

The rally looks strong, but investors shouldn’t be fooled. There was nothing in JCP’s holiday-quarter report that screams turnaround. Instead, most of the trends remain negative. Comps are still negative. Gross margins are still falling. The SG&A rate is still rising. Profits are still fading. The balance sheet is still loaded with debt.

To be sure, there appears to be some optimism among investors new J.C. Penney CEO Jill Soltau’s right-sizing plans. The hope is that aggressively closing stores and pulling the company out of the appliances market will reduce inventory overhead, stabilize sales and improve profitability.

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But, none of that is happening yet. Considering that JCP generated less than $600 million in EBITDA this year, sales and profits are falling and there’s still $4 billion in debt on the balance sheet. So the likelihood of bankruptcy is still high. As such, investors shouldn’t absorb that bankruptcy risk until there’s more clarity with regards to a turnaround. That means revenue growth has to turn around, gross margins have to stabilize or the opex rate has to normalize.

None of those things are happening yet. Until they do, any and all bounces in JCP stock are just dead cat bounces.

JCP Stock’s Numbers Still Aren’t Good

Wall Street is celebrating JCP’s first double-beat quarter in a year. Indeed, JCP did top estimates everywhere it matters. It was a big revenue and earnings beat with better-than-expected comparable sales performance.

But, those headline beats lack context. JCP didn’t beat regular estimates. They beat exceptionally depressed estimates that had fallen as a result of a weak holiday update in early January. Specifically, in early January, JCP reported that holiday sales had dropped an unimpressive 3.5% on a shifted basis. Analysts consequently cut their estimates, from $0.15 in Q4 EPS to $0.11.

Thus, JCP came in and beat depressed estimates. That isn’t all that impressive. It’s even less impressive when you look at the actual numbers. Comparable sales fell 4%, against an up 2.6% lap, so comps are still down on a two year stack basis. Gross margins fell by 220 basis points, roughly the same magnitude of compression as last quarter. The SG&A rate rose 150 basis points year-over-year, a bigger expense rate expansion than last quarter. Operating margins were whacked.

Overall, the numbers here still aren’t good. Sure, there’s some reason to believe that a new CEO will change things, and that her plan of right-sizing operations and slimming down the product portfolio could stabilize sales and margins. It makes sense. It’s a good plan. But, it’s also a tall order, and there are secular challenges here, including that consumers are simply just fine without JCP in their lives thanks to the expanding dominance of Amazon (NASDAQ:AMZN).

As such, investors shouldn’t buy into the JCP turnaround thesis until the numbers corroborate that thesis. Right now, they don’t. It’s that simple.

JCP Bankruptcy Risk Still Too High

At the end of the day, the most likely destination for JCP is still the retail graveyard, regardless of Q4 numbers.

The reality is that the whole retail world has moved on from JCP. Over the past several years, the online and offline commerce worlds have converged to satisfy relatively stable consumer demand, meaning that the offline retail world has shrunk as the online retail world has grown.

As it continues to shrink, some offline retailers who failed to keep up with the times will inevitably go under. JCP is one such retailer. The company hasn’t really built out a formidable e-commerce, let alone omni-channel commerce, presence. The product offering isn’t distinguishable. Stores are old and outdated. Prices aren’t all that compelling next to Amazon or Walmart (NYSE:WMT).

In other words, as the retail world has evolved over the past several years, consumers have grown to a point where they don’t really need JCP to be around any longer. Consequently, the most likely path forward for JCP is continued demand erosion, which will lead to a secular decline in revenues, margins, and profits.

Of course, this thesis may not materialize as expected. JCP may turn things around. But, considering that there’s $4 billion in debt on the balance, investors will want to wait on the numbers turning around before betting on a JCP turnaround. That isn’t happening today, nor will it happen anytime soon. As such, the sidelines remain the safest place to hang out.

The Bottom Line on JCP Stock

JCP’s Q4 numbers were better than expected, and JCP stock is soaring in response. But nothing about those numbers imply that a big turnaround is coming. If anything, the numbers confirm that JCP remains the eyesore of a shrinking offline retail world. As such, bankruptcy risk is still high — too high to buy into the JCP stock rebound.

As of this writing, Luke Lango was long AMZN. 

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