jc.-penney-holiday-results-were-negative-but-could-have-been-worse

J.C. Penney: Holiday Results Were Negative, But Could Have Been Worse

J.C. Penney's (JCP) holiday sales update came in with sales below my expectations. Although holiday retail sales looked to be trending fairly well overall before, it appears that December was generally weaker than November, and that department stores did relatively poorly (unlike last year).

The holiday sales update does also show that J.C. Penney's situation doesn't appear to be degenerating rapidly though, likely giving Jill Soltau enough time to carry out her plans for an attempted turnaround.

Comps Remain Negative

J.C. Penney reported -5.4% comps during November/December 2018 on an unshifted basis and -3.5% comps during that period on a shifted basis (to compare like-for-like weeks after the 53-week retail year in 2017).

I had thought that JCP may have been able to get to flat to slightly positive comps for Q4 2018 due to a holiday season that looked fairly strong for retail, along with favorable weather for sales of cold-weather apparel.

On the negative side, J.C. Penney fell around 4% short of what I believed it could get to, and still reported fairly negative comps despite an environment that seemed conducive to good sales results.

On the positive side, the comps trends on a shifted basis improved 1% quarter-over-quarter from Q3 2018's -4.5%. As well, the two-year stacked comps for November/December 2018 appear to be approximately -0.2% compared to -2.9% for Q3 2018.

My takeaway from this is that J.C. Penney still has significant challenges as it is falling well short of positive comps despite a fairly favorable retail environment. That being said, Q4 2018's results also indicate that its situation doesn't appear to be deteriorating further. In this environment, Soltau should have two to three years to demonstrate a solid turnaround in J.C. Penney's situation.

The caveat is that J.C. Penney is quite vulnerable to a marked deterioration in the retail environment. A recession (or a significant slowdown in the economy) early in Soltau's tenure could doom any hope for a turnaround. A Wall Street Journal survey of economists indicated that they believe there is a 25% chance of a recession in 2019.

Results Versus Competitors

J.C. Penney's shifted comps lagged around 7% behind Kohl's (NYSE:KSS) shifted comps in Q3 2018, but only lagged 4.7% behind Kohl's for November/December 2018. Similarly, the gap between J.C. Penney's and Macy's comps narrowed by a couple percent in November/December 2018 compared to Q3 2018.

However, it doesn't really help J.C. Penney if the gap between its performance and its competitors' performance narrows due to its competitors seeing slowing growth. J.C. Penney needs its own results to improve. Still, I would consider the narrowing of the comps gap between J.C. Penney and its competitors another sign that its situation hasn't become completely unrecoverable yet.

Free Cash Flow And Inventory

J.C. Penney also mentioned that it expects to generate positive free cash flow in 2018, although that appears to be driven by a combination of inventory reduction and asset sales.

The company indicated that 2018 year-end inventory levels were expected to be at least $225 million (or 8%) below year-end 2017 inventory levels. This was more than the 6% reduction it was envisioning in November for the end of 2018 and may result in J.C. Penney entering 2019 with a fairly clean inventory situation. Gross margins are probably not going to be pretty for Q4 2018, but cleaning up the inventory improves the outlook for 2019.

JCP also reported $132 million in proceeds from the sale of operating assets, so generating positive cash flow isn't much of an achievement. The company will need to prove that it can generate positive cash flow independent of asset sales and inventory reductions. It does seem that J.C. Penney's liquidity situation will probably be fine until closer to its 2022 credit facility maturity at least.

Conclusion

J.C. Penney has significant challenges, with Q4 2018 looking like it will be a second consecutive quarter with noticeably negative comps. However, it doesn't appear that its situation is getting rapidly worse, which should at least allow Jill Soltau an opportunity to turn the company around. JCP's liquidity situation looks fine for now as well, although there is a risk that a recession could derail any chance of a turnaround.

Free Trial Offer

We are currently offering a free two-week trial to Distressed Value Investing. Join our community to receive exclusive research about J.C. Penney and other companies along with full access to my portfolio of historic research that now includes over 1,000 reports on over 100 companies.

Disclosure: I am/we are long JCP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Long JCP via KTP.

SeekingAlpha