Despite $586M Loss, Penney’s Sees Progress

While it was a disastrous second quarter for the retailer, there were some positives that bought J.C. Penney more time, at least through holiday.

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One step at a time.

This story first appeared in the August 21, 2013 issue of WWD.  Subscribe Today.

While it was a disastrous second quarter at J.C. Penney Co. Inc. — the $586 million loss was wider than expected — there were some positives that bought the retailer more time, at least through holiday.

That cheered investors, who sent shares of Penney’s up 5.9 percent on Tuesday to close at $14 in Big Board trading.

For the second quarter ended Aug. 3, the loss widened to $586 million, or $2.66 a diluted share, from a loss of $147 million, or 67 cents, a year ago. The adjusted net loss, excluding charges such as retirement of debt, restructuring and management transition costs, was $477 million, or $2.16 a share. The consensus estimates by Wall Street analysts pegged the loss at $1.06 a share on revenues of $2.76 billion.

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Net sales fell 11.9 percent to $2.66 billion from $3.02 billion. Comparable-store sales also declined 11.9 percent, seen as an improvement given that comps decreased 21.7 percent in the year-ago period. Gross margin fell to 29.6 percent of sales, compared with 33.2 percent a year ago.

For the six months, the loss was $934 million, or $4.24 a diluted share, from a loss of $310 million a year ago. Net sales decreased 14.2 percent to $5.3 billion from $6.17 billion. Comps were down 14.3 percent for the first half on top of a 20.3 percent drop in the year-ago period.

While the early read on women’s apparel sales saw them strengthening heading into the fall selling season, the home category continues to drag down overall operations. Liz Sweeney, who heads merchandising, has also taken on the responsibility of respositioning the home store. What that may entail exactly is unclear as the company said it only plans $300 million in capital expenditures for 2014.

Liquidity was a top concern in the financial community prior to the release of the results, and this time the retailer didn’t disappoint. The company had said it expected to end the year with $1.5 billion in overall liquidity, and on Tuesday it reiterated that projection. The $1.5 billion is a combination of current cash position and the undrawn component of its credit facility.

The company entered into a $2.25 billion senior secured loan facility in the quarter and paid $355 million to complete a cash tender offer in connection with its 7 1/8 percent debentures that were due in 2023. It did draw down about $439 million for capital expenditures in the quarter and spent $357 million to increase inventory for the restocking of basic items.

During the conference call to Wall Street, chief executive officer Myron “Mike” Ullman 3rd provided an update on management’s efforts to turn around operations. Much of the blame was placed on the prior executive team led by former ceo Ron Johnson. That’s not a surprise given that the prior team’s failed plans to reinvigorate the retailer left the company ending 2012 with a $1 billion loss and a 25 percent decline in sales.

Not mentioned was the recent internal board fight that had investor William Ackman resigning his board position.

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What Ullman did focus on was how Penney’s intends to get its core customer base — essentially the Baby Boomer demographic — back into its stores. So far the strategy seems to be going back to its three-stool mix of national brands such as Nike and Levi’s, exclusive brands and private label, such as the $1 billion St. John’s Bay business that had been eliminated. The retailer also turned some attention to its e-commerce business, which saw improvement. That also wasn’t a surprise given that the prior team essentially ignored that component of the business to focus on the store concept.

Ullman said, “Over the last four months or so since I returned to the company, we’ve been focused on moving as quickly as possible to stabilize the business, not just financially, which we’ve made meaningful progress on, but also operationally, including merchandising, marketing, store experience, jcp.com as well as the leadership team.”

He noted that the retailer, like others in the sector, is facing headwinds of declining traffic given the economic backdrop.

But he also emphasized the company “knows where the problems are. We know how to address them and we have the right plans and places to do the job successfully and get back on a path to return to profitable growth. It’s no secret that the company’s prior merchandising promotional strategies weren’t working. We had to make changes. But these changes take time and they have financial implications — whether in the form of additional markdowns, investments in additional inventory or investing in additional staff store hours. We had to get back by listening and putting the customer first.”

Ullman said the top priorities have been to improve traffic and purchase conversion. “Bringing back promotions was a critical first step. It has taken time to find the right messaging of promotional cadence, but the response to our back-to-school marketing messaging, which we launched late in the period, has been promising,” the ceo said.

He said there are encouraging signs during the tax-free weekends and promotional weekend periods, and that the retailer has started to get merchandise assortments and stocks back to where they need to be.

Ullman added that St. John’s Bay for women is only half stocked and should be fully stocked in the third quarter. Likewise, Arizona, another big private-label brand for Penney’s, has seen an increase in inventory levels in time for back-to-school.

“As I told you in May, coming into the second quarter, we’re going to be out of stock in key basic items for our customers, which they trusted us to have when they came to J.C. Penney. We spent the last three months getting back in stock and what the customers need, and we fully expect to be in great shape by the fourth quarter,” Ullman said.

Despite the uptick in Penney’s stock, Wall Street’s reaction was mixed. While some analysts were concerned about customer traffic and conversion rates, others were encouraged by the early read on b-t-s and the rebuilding of basic assortments.

J.P. Morgan’s broadlines, apparel and footwear analyst Matthew Boss has a “neutral” rating on Penney’s stock, given its prolonged turnaround.

The second-quarter results provide ammunition for bulls and bears, noted Boss. While there were some pluses — Penney’s ended the quarter with $1.54 billion in cash and cash equivalents, and total available liquidity of $1.85 billion — there was also a negative as August traffic was challenged.

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“Comments on the call reflect a prolonged turnaround with traffic trends remaining negative in August [along with a] return to positive same-store sales not expected until late third quarter with gross profit margin improvement in the fourth quarter,” Boss said.

Paul Lejuez, senior analyst at Wells Fargo, has an “underperform” rating on the stock. He said, “This is a company selling product at lower margins than a year ago, and they still can’t drive traffic or conversion — both were down — which tells us many of the customers they lost are gone for good.”

Other reasons for the underperform rating include a “re-redo” of its home departments, even though there are plans to decrease capital expenditures in general, and the need for investment in marketing. “If results don’t improve significantly in the second half, the company may need additional liquidity next year to fund working capital,” Lejuez concluded.

Walter Loeb, a retail consultant, said, “This is an inflection point for the company. Sales will go up in September and October.” Loeb believes sales will go up in the third quarter and forecasted a “15 percent rise in sales for the fourth quarter.”

Bernard Sosnick, analyst at Gilford Securities, rated Penney’s stock a “buy,” noting that while uncertainty remains, “we believe the business is stabilizing and that upside potential exceeds downside risk.”

Sosnick said, “There is light at the end of the tunnel. The stores look better, inventory balance is improving, marketing efforts should lift sales versus a year ago, and online sales, which had been plummeting, were down only 2.2 percent,” in the second quarter, which he noted was an encouraging sign.

Sosnick also said he wouldn’t be surprised if sales increase 10 to 15 percent by the fourth quarter and during the first half of 2014. “If that happens, we believe Penney’s shares will be moving back to $20 or above,” he concluded.


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