J.C. Penney's Virtuous Vigilance

Typically, when a company beats analyst estimates as widely as J.C. Penney (NYSE: JCP  ) did in its fourth quarter, investors get exuberant and the stock skyrockets. But throw in cautious 2008 prospects, and the earnings beat gets lost in the negative guidance announcement.

That's exactly what happened to the retailer after releasing results this morning. Quarterly sales slipped 4.1% against an extra week last year, and comps fell 2.3% overall after a disastrous December in which same-store sales dropped 7.5%.

On a pre-holiday shopping trip late last year, I noted that everything seemed to be on sale. As you might expect, margins took a nosedive (down 180 basis points) on heavy clearance sales. And the margin pain isn't over yet. Management reported that inventories are now 7% higher than last year.

Amid all this gloom, there is a bright side. SG&A expenses were slashed 11% below prior-year levels, allowing the company to earn $1.93 in EPS for the quarter -- down 3.5% from last year, but well above the $1.77 expected by the Street.

However, the company adopted a somber tone toward 2008, guiding to a low-single-digit comp sales decline for the year, with operating income and EPS trailing down as well. Management noted that it sees no indication that consumers will open up their wallets. As a result, J.C. Penney's leadership is continuing its vigilant approach to expenses, inventory management, and capital spending.

This looks to me like a virtuous approach to 2008, since much of the retail world suffered a tough December. Kohl's (NYSE: KSS  ) reported an 8% plummet in comps in December, and even former highfliers like Abercrombie & Fitch (NYSE: ANF  ) and American Eagle Outfitters (NYSE: AEO  ) are reporting tepid results.

With consumer spending's near-future direction uncertain, J.C. Penney's conservative approach seems like the appropriate model for an apparel retailer. While growth will ultimately continue to slow, the company's prudent plan will stem the bleeding, should the sluggish retail environment persist. And if sales improve, the company should be positioned favorably.

Trading at a trailing-12-month P/E of 9.5, J.C. Penney is selling well below its historical average. In this economic environment, it's hard to say the stock is cheap right now. But once consumers start spending again, J.C. Penney's vigilance should pay off for investors who were willing to wait.

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