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"Huh?" was probably the most common reaction to J.C. Penney's (NYSE: JCP ) performance on Friday. The company delivered what was by all accounts a terrible quarter -- including a removal of all earnings guidance -- but yet the stock ended up 5.8%.
How could this be? The answer may surprise you.
Why it wasn't valuation
One possible explanation is valuation. I've written before about how the stock is cheap on the basis of assets and recession-level normalized free cash flow. It could be that as bad as the results were, they weren't as bad as the market was expecting. The market then came to its senses and agreed with me.
Alas, this explanation -- as much as it strokes my ego -- falls short.
In pre-market trading, the stock was down as much as 12%. So it doesn't look like the market had a change of heart with the results. It seems more likely that something happened between pre-market trading and market closure.
And something did happen: Ron Johnson happened, that's what. At about 9 a.m., he showed up in New York to elaborate on the results. And his presentation included some bombshells.
Say goodbye to sales (the event kind)
One notable bombshell came about a quarter of the way through the presentation: Along with eliminating coupons, J.C. Penney is now eliminating all sales. Before, Ron Johnson had reduced sales to one per month, but now there won't be any sales at all. (This was announced earlier at the Fortune Brainstorm conference, but strangely wasn't widely reported.) The actual removal of sales happened in stores about 10 days ago.
An expedition to my local J.C. Penney in Wheaton, Md., (what Wall Street might call a "channel check") bore this out. There were no "sale" signs anywhere in the store. Imagine that -- a department store with no sale signs! We've come to expect this to some extent from Wal-Mart and Target, but this is wholly new for a classic department store.
When I walked over to Macy's (NYSE: M ) , the difference was obvious: There were sale signs everywhere. Everything was on sale, which of course meant that nothing actually was.
The same pair of Levi's I spotted at Macy's on sale for $39 -- allegedly "marked down" from $58.99 or so -- was $40 every day over at Penney's new Levi store-within-a-store. For what it's worth, I didn't really notice a difference in traffic between Macy's and J.C. Penney, either. The men's Levi store-within-a-store was also noticeably busy and low on inventory.
And it turns out my Levi's store-within-a-store hasn't been alone in its apparent success. That was the real bombshell of the presentation.
Sales of Levi's up 25% thanks to store-within-a-store
Strangely, I haven't seen any articles discussing Johnson's biggest bombshell of all: Sales of Levi's have been up 25% year over year for the first 10 days of the back-to-school season (for units that have the new Levi stores). And this is an honest square-foot-for-square-foot comparison.
No one is talking about it, but this is a huge deal. Johnson's strategy, after all, is to convert J.C. Penney into a mall-within-a-mall consisting of individual stores like Levi's. Levi's being up 25% year over year is the first piece of tangible evidence that store-within-a-store works. The average Levi's transaction price was up $5, too.
Granted, it was only 10 days. But these weren't any ordinary 10 days. These 10 days were during one of the most promotional periods in retail -- back to school. J.C. Penney was out in full force with its promotional coupon efforts last year, so for the 10 days comparison to be positive is a big deal.
To put it in perspective, when J.C. Penney was up against similar levels of promotion in the spring, sales for the whole store were down 31% year over year at best. Yet against heavy promotion, Levi's sales were still up 25% for the first 10 days.
But it gets better. For the first 10 days traffic was down only 7% year over year and sales (for the whole store) were down only 19%. Considering that they expected sales to be down 30% due to heavy promotional efforts of 2011's back-to-school season, this is good news. It also represents an absolute improvement over the first six months' results, which includes both strong and weak promotional period comparisons.
Bottom line is that there are now glimmers that the new sale-less marketing and store-within-a-store are working. I think this is the real reason shares rallied. This, in addition to shorts covering, thanks to management plans to have $1 billion in cash on hand by the end of the year, which I think panicked many of the "they're going bankrupt" shorts.
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