U.S. Markets closed

Is It Finally Safe to Buy J.C. Penney Stock?

Leo Sun, The Motley Fool

Shares of J.C. Penney (NYSE: JCP) recently rallied after the department store chain's fourth-quarter numbers topped Wall Street's expectations. Its total revenue fell 8.4% annually to $3.79 billion, but still beat estimates by $60 million. Excluding its credit income, gains from store closings, and other non-core revenue, its net sales fell 9.5% to $3.67 billion.

However, J.C. Penney's fourth quarter only included 13 weeks, compared to 14 weeks a year ago. Its "unshifted" comparable store sales, which directly compare the two periods, fell 6%. On a "shifted" basis, which better aligns the two calendar years, its comps declined 4%.

A J.C. Penney store.

Image source: J.C. Penney.

J.C. Penney's adjusted net income tumbled 64% to $57 million, or $0.18 per share, which still beat estimates by seven cents. On a GAAP basis, its net income fell 69% to $75 million, or $0.24 per share, which also beat expectations by $0.17.

J.C. Penney's numbers look dismal, but some investors clearly believe that the stock -- which briefly dipped below $1 in late 2018 -- could finally rebound. But is it too early to declare that J.C. Penney is out of the woods?

The key numbers

J.C. Penney's comps growth flatlined in the beginning of 2018 and stayed negative for two straight quarters.

 

Q4 2017

Q1 2018

Q2 2018

Q3 2018

Q4 2018

Comps growth

2.6%

0.2%

0.3%

(4.5%)*

(4%)*

Source: J.C. Penney quarterly reports. *Shifted basis.

Its soft fourth-quarter growth was particularly disappointing, since U.S. retail sales hit their highest levels in six years during the 2018 holidays according to Mastercard SpendingPulse.

However, Mastercard's survey mainly attributed that growth to apparel and home improvement retailers. Department stores, meanwhile, suffered a year-over-year decline due to weak traffic and store closings.

Nonetheless, J.C. Penney's comps growth still compared poorly to other department stores' results. Macy's (NYSE: M), for example, posted 2% shifted comps growth (on an owned-plus-licensed basis) last quarter.

Like Macy's, J.C. Penney is vulnerable to competition from Amazon, Walmart, Target, and fast fashion retailers. Several major management changes, including the losses of several executives and the appointment of Jill Soltau as the new CEO last year, also disrupted its turnaround attempts.

Soltau's first move was to flush out J.C. Penney's inventories to right-size its stores and make room for newer products. That's why its inventories fell 13% annually during the quarter. However, its use of steep markdowns reduced its gross margin 220 basis points annually, but failed to boost its comps back to positive levels.

Appliances for sale at J.C. Penney.

Image source: J.C. Penney.

Soltau believes that its gross margin contraction will be temporary since the store is clearing out lower-margin appliances and furniture to bring in higher-margin apparel and soft home goods.

J.C. Penney also plans to close 18 full-line stores, including nine smaller home and furniture stores, to cut costs and pivot its spending toward the "locations and initiatives that offer the greatest long-term value potential." Most of the store closures will occur during the second quarter.

J.C. Penney reduced its total costs and expenses by 6% annually to $3.66 billion during the quarter, but its operating margin still contracted from 5.9% to 3.4% due to its negative sales growth. For comparison, Macy's reported an operating margin of 7% last quarter.

A murky outlook

J.C. Penney achieved a positive free cash flow (FCF) of $111 million for the full year, but that growth mainly came from asset sales. Excluding those asset sales, its FCF still came in at negative $33 million, compared to positive $59 million on the same basis in fiscal 2017.

J.C. Penney expects its FCF to stay positive in fiscal 2019, but it didn't state how much of that growth would come from asset sales. It also didn't offer any sales, comps, or earnings guidance for the year.

Maintaining a positive FCF will help J.C. Penney gradually extinguish its long-term debt, which only dipped 2% annually to $3.72 billion during the quarter. Reducing that debt to more manageable levels could spare J.C. Penney from the same fate as Sears Holdings.

However, relying too heavily on store closures and asset sales could reduce its brand awareness, while cutting its operating expenses could cripple its ability to counter the competition with bold marketing campaigns.

Is J.C. Penney out of the woods?

J.C. Penney is desperately trying to evolve into a smaller and more profitable retailer. Its better-than-expected earnings for the fourth quarter and positive FCF target for 2019 indicate that it isn't headed off a cliff yet.

However, J.C. Penney's revenue growth remains negative, and its turnaround plans remain unclear. Therefore, J.C. Penney isn't out of the woods yet, and investors shouldn't buy this stock until it presents a clearer roadmap for long-term growth.

More From The Motley Fool

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Leo Sun owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon and Mastercard. The Motley Fool has a disclosure policy.