JCP’s revenue declined, yet gross margin improved.
I am beginning to see CEO Jill Soltau’s vision. Focusing on fewer products with acceptable gross margins appears to be working.
EBITDA fell as the company was not able to cut into SG&A costs.
Its $3.7 billion debt load is at 6.5x EBITDA. Until JCP can improve its credit metrics, the stock remains a sell.
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J.C. Penney (JCP) reported quarterly revenue of $3.49 billion, GAAP EPS of $0.13 and Non-GAAP EPS of $0.21. The company beat on earnings and revenue. JCP is practically flat post-earnings. I had the following takeaways on the quarter.
Same-Store Sales Faltered, Yet Margins Improved
The revenue and earnings beat was positive. J.C. Penney must still prove it is capable of competing in a digital world. The company is facing stiff competition from Amazon (AMZN) and traditional retailers like Target (TGT) and Walmart (WMT) with formidable digital platforms. Off-price retailers like Burlington (BURL) and TJX (TJX) are winning with customers that are price-conscious and fashion-conscious. J.C. Penney appears to be caught somewhere in the middle. The company’s total revenue of $3.5 billion fell 8% Y/Y. Comparable sales fell 7%, implying sales through bricks and mortars are becoming less efficient.
This followed a 9% comparable sales decline last quarter, which was hurt by the company’s exit from major appliances and certain furniture categories. Management divulged the comparable sales decline may not have been as bad as it looked:
During the second half of the year, six of our eight merchandise divisions showed an improvement in comparable store sales over the first half of the year. The biggest improvements were in, women’s apparel, women’s accessories, footwear and home within continuing categories. We still have work to do on our top-line. As I have said before, we are not just running a business, we are rebuilding a business.
We strongly believe that growing sales in unprofitable way is simply not an option. Instead, we are guided by our plan for renewal and we’ll continue to be measured and methodical in our approach.
The improvements in women’s apparel and footwear were encouraging, especially since certain retailers have struggled in women’s apparel.
Management’s intimation that J.C. Penney is seeking profitable growth makes sense. Secondly, the financial results imply the strategy could be working. The company reported a gross margin of 33%, up 200 basis points versus the year earlier period. This followed a 300 basis point improvement last quarter. Gross profit of $1.1 billion was flat Y/Y, despite the decline in revenue. If having a laser focus on fewer items is making the company more profitable, then it could energize JCP bulls.
SG&A expense was $1.0 billion, flat Y/Y. Therein lies the rub; while management improved gross margin, it was unable to cut into SG&A costs. Retailers must spend money to make money. J.C. Penney must invest in its nascent digital platform and improve fulfillment services to keep pace with competitors. That spending can strain operating income. The fallout was that EBITDA of $231 million fell 11% Y/Y. EBITDA margin of 7% was off about 30 basis points versus the year earlier period. To grow EBITDA, management must further improve gross margin, cut into SG&A costs or both. That sounds like a tough task amid heightened competition in retail and an economy that likely has peaked.
Debt Remains Elevated
J.C. Penney ended the quarter with $3.7 billion in debt. Based on last 12 months («LTM») EBITDA of $569 million, its debt-to-EBITDA was 6.5x. This is not only below investment grade, but it is concerning given the company’s declining EBITDA. J.C. Penney likely needs to make continuous improvement to its online capabilities. This type of investment could strain its $386 million in liquidity. If the company can grow EBITDA, then its outlook could change. I will take a wait and see attitude for now.
JCP Still Below $1
JCP broke the buck in mid-January. In late January the New York Stock Exchange (NYSE) notified the company that it was no longer in compliance with NYSE listing criteria. The NYSE requires listed companies to maintain an average closing share price of at least $1 over a consecutive 30 trading day period. JCP currently trades under $0.70 per share, despite the recent 50 basis point rate cut by the Federal Reserve. Management intimated it would raise the share price above $1 by improving the company’s operating performance:
Our 30-day average closing share price fell below $1 as of January 30th. We intend to increase our share price to above $1 through improvements in our operating performance as we did this past December. We will go into detail about those improvements and walk you through the three year financial outlook during our upcoming Analyst Day.
Management could potentially perfect a reverse stock split in order to drive the price above $1. However, it may not improve the long-term health of the company. Continued margin improvement and debt pare downs could change J.C. Penney’s fortunes, but that could take a while. In case all else fails, a reverse stock split could be in the cards by the first half of this year.
Conclusion
JCP is down over 60% Y/Y. Margin improvement was encouraging, but the company is not out of the woods yet. JCP remains a sell.
