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Can J.C. Penney Steer Clear of the Iceberg?

- By John Kinsellagh

Holiday sales reports for chain retailers have been trickling in recently and, overall, the results have been mixed. Target (TGT) leads the pack with same-store sales growth of 5.7% for the recent shopping season, a 3.4% increase from the prior year. Macy's (NYSE:M) posted same-store sales growth of 1.1%, below analysts' expectations. Kohl's (KSS) logged a 1.2% increase in same-store sales compared to last year's 7%.

Struggling retailer J.C. Penney (JCP) logged the worst results in the same-store sales report card, recording a 3.5% decrease in same-store sales. The company finds itself in the intensive care unit of the struggling brick-and-mortar sector; its financial condition grim. Free cash flow has remained negative for the past 12 months and, most foreboding, the company has a long-term debt load of $4.2 billion, $2 billion of which matures in 2023. J.C. Penney's stock currently trades slightly above a dollar. The bond market has a dim view of the company's prospects; its 6.375% bonds due in 2036 are trading well below par at 37 cents.

A review of the company's comps growth is not reassuring. First and second-quarter comps growth was 0.2% and 0.3% respectively, then tanked in the fourth quarter at -5.4%.

Among the brick-and-mortar stores struggling for survival in the new Amazon (AMZN) online retail environment, J.C. Penney has been a ship that is rudderless, with no clear path to navigate out of its perilous position.

The booming economy has only served to bring the company's endemic problems into sharper focus. As many analysts have justifiably claimed, if traditional retailers can't tread water in a strong economy, where consumer confidence and spending are at historic highs, then there is probably something seriously wrong with their core business model.

J.C. Penney's business model has continually been in a state of flux. The company has gone through a plethora of strategies to respond to the changing retail environment led by discounters and off-price chains like TJX Companies (TJX). The price of the company's stock seems to rise and fall in tandem with each of its new business strategies: dropping from $80 a share during the last recession to barely one dollar today.

In another ominous sign for the company, many senior executives have abandoned ship with the result that many C-level positions remain vacant at a crucial time. Additionally, given the existing turnover, it is difficult to recruit the necessary talent in light of the perennial strategy shifts the company has implemented within a relatively short period of time. As a result, the company now has a brand identity problem.

For many consumers, the question is: where do I go to shop for apparel? At one time, their destination might have been J.C. Penney, but now that the retailer has elevated appliance sales at the expense of clothing, fewer consumers are going to be drawn to its stores. In this regard, the company is eerily following the path of its onetime competitor Sears (SHLDQ). Sears changed its strategies throughout the last decade, emphasizing its appliance business, then showcasing its Craftsman tool brand while paying lip service to apparel, which at one time was its dominant revenue generator.

The brick-and-mortar business over the past decade has developed into a Darwinian environment: adapt or die; survival of the fittest is now the climate in which all retailers must compete with the e-commerce Goliath Amazon. The gap between the successful and the moribund has widened considerably over the past three years.

Analysts' patience with J.C. Penney has been exhausted. Most investors believe there can be little hope for a retailer's prospects for the future if it can't take advantage of the tailwinds provided by one of the most favorable consumer spending environments in over a decade. What happens to those faltering if the economy should skip a beat?

Due to the substantial investment many retailers such as Walmart (WMT), Macy's and Nordstrom (JWN) have made in expanding their e-commerce and online shopping strategies, the Street, for the moment, seems to have withheld judgment on their long-term viability. Target has successfully implemented a melding of a traditional in-store shopping environment with a robust online presence that presents customers with an integrated and convenient shopping experience.

The success of Target dispels the death star prognosis many analysts have consistently and unreasonably maintained for the fortunes of the entire brick-and-mortar retail sector. A close look at other retailers indicates they are investing heavily in developing an online and in-house total shopping experience by taking advantage of their strong geographical footprints to make it easier for customers to pick up online orders in nearby stores. This is precisely the strategy Target has pursued assiduously, and the results are paying off. One difference between Target and stores such as Macy's and Nordstrom is that it started the implementation sooner. A floundering J.C. Penney hasn't even begun a hybrid operation that increasingly appears to be a necessary component for success in an Amazon world.

A review of the following charts contrasting the revenue history and operating margins of J.C. Penney and Nordstrom tells the tale.



The problem for J.C. Penney is that it has not shown any growth or shift to establishing a strong online component incorporated within its overall sales strategy, and it is running out of time.

Last November, the company's new CEO, Jill Soltau, told analysts that she was still formulating her strategy for the struggling retail chain. This equivocation did not inspire much confidence in her leadership, nor the fortunes of the company. J.C. Penney's decision to get back into the appliance business, in order to gain some market share from Sears, in hindsight, seems to have been ill-advised, as the retailer now finds itself poised to join its one-time competitor in the graveyard.

Although some investors argue the company has time to implement its new strategy by improving its free cash flow through refinancing and inventory reduction, this prognosis seems sanguine and ignores the peril now facing the company from its past lapses in judgment, lack of a focused and consistent strategy and its constantly changing identity in the marketplace.

The stock as well as the company's deep discount bonds present a turnaround play for enterprising investors with strong stomachs.

The lesson of this past holiday season? A rising consumer spending tide doesn't lift all boats. A rudderless J.C. Penney seems to be heading straight for an iceberg and has done little more than rearrange the deck chairs to avoid imminent disaster. If a drastic course correction isn't implemented soon, the S.S. J.C. Penney may find itself at the bottom of the sea with its one-time rival Sears.

Disclosure: I have no position in any of the securities referenced in this article.

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This article first appeared on GuruFocus.