J.C. Penney (NYSE: JCP) recently posted its third straight quarter of negative comparable-store sales, dousing hopes that CEO Jill Soltau, who took the top job last October, would halt the retailer's downward spiral. J.C. Penney's comps declined 5.5% in the first quarter as its revenue fell 5.6% to $2.44 billion.
Its adjusted net loss widened from $69 million to $147 million, or $0.46 per share, which missed estimates by $0.07 per share. On a GAAP basis, its net loss widened from $78 million to $154 million.
Image source: J.C. Penney.
Those dismal headline numbers support the bearish thesis that Amazon, Walmart, and fast-fashion retailers are killing the aging retailer. Let's dig deeper to see if things are really that bad.
What happened to J.C. Penney?
Like many brick-and-mortar retailers, J.C. Penney is struggling with sluggish mall traffic, shifting shopping trends, and changing consumer tastes. Murky turnaround plans under four CEOs over the past ten years also left the company rudderless.
J.C. Penney's comps flatlined at the beginning of 2018, then turned negative in the second half as the company's declines accelerated.
Source: J.C. Penney quarterly reports. *Shifted basis.
J.C. Penney attributed its first quarter decline to the eliminations of its major appliance and in-store furniture categories, which offset stronger sales of its fine jewelry, children's apparel, women's apparel, and men's apparel.
What's the turnaround strategy?
Since taking the helm, Soltau focused on clearing out the retailer's excess inventory to make room for newer products. That clearance strategy reduced J.C. Penney's inventory 16% annually during the quarter, but resulted in wider losses.
J.C. Penney's cost of goods sold accounted for 66.8% of its net sales during the quarter, representing a half percentage point increase from the prior year. However, that included a larger headwind from its exit from the appliance and furniture businesses, which indicates that the gross margin of its other businesses expanded slightly.
During the conference call, CFO Bill Wafford stated that gross margins for non-clearance products expanded annually across most categories, particularly in women's apparel. Wafford expects J.C. Penney's gross margins to continue rising throughout the year as it reduces its markdowns and expands its higher-margin apparel and home goods categories.
Those efforts are encouraging, but the markdowns aren't boosting the company's comps growth yet, and it didn't offer any comps guidance for the second quarter or the full year. Instead, J.C. Penney merely stated that it would generate positive free cash flow (FCF) for the full year as it focuses on liquidating lower-margin businesses, clearing out its inventory, and closing stores.
That should allay some concerns about the company's long-term debt, which was reduced 8% annually to $3.8 billion. However, those moves would only help J.C. Penney tread water -- only positive comps growth can help it swim forward again.
Image source: J.C. Penney.
The main catalyst for foot traffic is LVMH's (NASDAQOTH: LVMUY) Sephora, which operates stores in roughly three-quarters of J.C. Penney's U.S. locations. Sephora's stores-in-stores reportedly generate nearly five times as much sales per square foot than J.C. Penney's stores, and Soltau stated that the two companies were "moving forward in tandem" with "new initiatives".
However, Sephora also faces tough competition from Ulta Beauty (NASDAQ: ULTA). Ulta is clearly coming after Sephora's core customers -- UBS estimates that Ulta now has stores within a ten-minute drive of 78% of Sephora's J.C. Penney stores. Time will tell if Sephora and J.C. Penney's "new initiatives" will hold Ulta at bay.
Making the best of a bad situation
J.C. Penney made some smart moves during the quarter, but I'm not convinced that its comps growth will return to positive territory anytime soon. I'd stay away from this stock until that happens -- it clearly hasn't "right-sized" its business to the point that it can generate sustainable growth again.
More From The Motley Fool
- 10 Best Stocks to Buy Today
- The $16,728 Social Security Bonus You Cannot Afford to Miss
- 20 of the Top Stocks to Buy (Including the Two Every Investor Should Own)
- What Is an ETF?
- 5 Recession-Proof Stocks
- How to Beat the Market
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 and LVMH Moet Hennessy L.V. (ADR). The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends Ulta Beauty. The Motley Fool has a disclosure policy.