Making the Most of the Turnaround in Retail

This beaten and bruised retailer could finally be showing signs of life.

Jan 9, 2014 at 11:25AM

There has been a lot written about J.C. Penney (NYSE:JCP) over the last six months, and even more before that. Investors should look for the company to continue being one of the most volatile names in retail. However, for investors who like to invest in beaten-down and nearly broken companies, there might still be money to be made in Penney.

The company saw a minor inflection point last November, and it has enough liquidity to take it through 2014. Penney might be able to finally say that the turnaround has begun. Just last quarter, Penney posted earnings per share of a $1.81 loss, narrower than the prior quarter's EPS.

The retail battle
Macy's (NYSE:M) may have managed to capture some of Penney's lost market share, but it could be gaining that back. In addition, Macy's and Penney are still battling it out over Martha Stewart Living home goods. Macy's filed a lawsuit against Penney a couple of years ago, and the latest news shows that the two have ceased talks, and it's likely a judge will now settle the dispute.

On the store-traffic front, Penney is seeing strength of late thanks to its Thanksgiving opening and early morning Black Friday door-busters. This is good news, as the company likely won back some market share from Macy's.

Again, It has been a long road for Penney, and it still has a ways to go. However, it has put a number of initiatives in place to help. The key is the company has brought back promotions. As a result, November comps were up 10%, and the company believes comps will be up year over year for the fourth quarter. One of the keys to this is that the company has increased its assortments and better aligned its market strategy. In addition, Penney is turning towards a new rewards program.

Turnaround under way
J.C. Penney's revamped stores should also help bring in customers. Penney has been renovating and rehabbing its stores, while also pushing its e-commerce platform. As part of the renovations, Penney now has in-store Sephora departments to help draw the younger and more affluent customers that previously shopped at Macy's.

While the turnaround appears to have begun, there are some areas of concern. The most notable concern is  the company's significant weakness in earnings for more than eight quarters, as the retailer continues to post losses. And one of the biggest headwinds is the potential for continued weakness in the broader economy.

The other big winners of Penney's misfortunes were likely the discount retailers, such as TJX Companies (NYSE:TJX). TJX owns the TJ Maxx and Marshall's brands. TJX is a discount retailer and saw some strength during the weak economy as consumers traded down. Yet, as the economy shows strength of rebounding, we could see consumers trade back up to Macy's and Penney.

Penney trades at a mere 0.6 times enterprise value/sales multiple and right at 1 times book value, which is very cheap compared to its peers and the historical average. Over the last five years, Penney has traded at an average 1.4 times book value. In addition, TJX trades well above Penney, at 1.6 EV/sales and nearly 11 times book value. Macy's trades at 0.9 EV/sales and 3.6 times book value.

Bottom line
All in all, Penney is still a turnaround play, which means it has a lot of execution risk. Yet the big win is that November sales were positive, and it appears that the company is winning back market share thanks to solid Black Friday and Christmas traffic. The new traffic comes as Penney is getting back in touch with its core customers by offering promotions and streamlining marketing. It's also still very cheap.

J.C. Penney isn't the only retailer that has been suffering
To learn about two retailers with especially good prospects, take a look at The Motley Fool's special free report: "The Death of Wal-Mart: The Real Cash Kings Changing the Face of Retail." In it, you'll see how these two cash kings are able to consistently outperform and how they're planning to ride the waves of retail's changing tide. You can access it by clicking here.

Marshall Hargrave owns shares of J.C. Penney Company. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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