J.C. Penney's Margins Pinched

For retailers, falling short of last year's comps has pretty much been par for the course this earnings season. Yet J.C. Penney's (NYSE: JCP  ) contribution to that trend -- missing last year's numbers by more than half -- wasn't the most disturbing thing about its latest earnings release.

For the third quarter, the retailer earned $0.55, on a 10% year-over-year dip in comparable-store sales. It also issued fourth-quarter guidance that falls far short of analysts' hopes.

None of that really bothers me, though -- I'm a bit more worried about J.C. Penney's troubling margin problem.

Going beyond P/E
Though its use as a yardstick may be a tad overused at times, let's face it: Everybody loves a low price/earnings ratio. With a trailing P/E of less than 5, Penney looks attractive by that standard. But its low P/E doesn't say much about the future.

If you were considering a business venture of your own, and you were told for every $100 in sales you generated, you'd make a net profit of about $2.90, would you want to get into that business? Probably not. But that 2.9% profit margin is all J.C. Penney managed last quarter.

It's not doomsday -- net margins are notoriously paper-thin in retail -- but 2.9%? Just for comparison, Nordstrom's (NYSE: JWN  ) profits fell 57% last quarter, but its margin remained closer to 4%. Kohl's (NYSE: KSS  ) cleared about 4.2% of its revenue.

More importantly, the numbers are way down from Penney's historical averages, which have typically run closer to 4% for the third quarter. And even though a one-percentage-point different may seem microscopic, by retail standards, the disparity is reaching scary levels for J.C. Penney.

Higher margins for Christmas?
I'm not saying Penney's is on the verge of a loss. In fact, it's looking for a profit somewhere in the neighborhood of $1.00 per share for the current quarter, which I consider highly likely. If the economy worsens before it improves, though -- and forces heavy markdowns -- the fourth quarter could be especially nerve-racking for J.C. Penney. Let's just hope its thin margins don't become a habit.

If your holiday spirit has overridden the effects of October's retail sales slump, and you're determined to invest in retail stocks, I think you might be better served by investigating Kohl's or TJX (NYSE: TJX  ) . Both combine reasonable stock prices with less worrisome margins. In fact, TJX enjoyed net margins of almost 5% last quarter, thanks to a healthy top-line boost.

Meanwhile, Penney's investors should hope for a Christmas gift of better times -- even if they won't actually get it until next year.

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Fool contributor James Brumley doesn't shares of any of the companies mentioned above. Try any of our Foolish newsletter services free for 30 days. The Fool's disclosure policy takes a 32 long, and prefers cotton to wool..


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