J.C. Penney Explodes Higher: Buying Opportunity or Time to Run?

Source: J.C. Penney.

J.C. Penney (NYSE: JCP  )  stock has risen by more than 50% over the last week as investors are gaining confidence in the company's chance to implement a successful turnaround. The retailer is clearly making material progress, but the industry is quite challenging and J.C. Penney is still an unprofitable company carrying substantial financial risk. So is this a buying opportunity or a time to run?

The good news
Excluding the 53rd week in 2012, total sales during the quarter ended on Feb. 1 increased by 1.6%. Comparable-store sales grew by 2% annually during the quarter, and J.C. Penney delivered a 3.1% increase in comparable-store sales during the key holiday period of November and December. Sales are stabilizing and that's a big improvement for the company.

Gross margin came in at 28.4% during the quarter, a material increase of 460 basis points versus the same quarter in the previous year, in spite of the fact that J.C. Penney discontinued several brands during the period.

The company generated positive free cash flow of $246 million, and J.C. Penney ended the year with total available liquidity in excess of $2 billion, so its  financial position is also showing signs of progress and stabilization.

J.C. Penney is still in the red when considering adjusted net income, but the company seems to be moving in the right direction in terms of growing sales and improving profitability.

Furthermore, forward guidance was quite optimistic; management is expecting comparable-store sales to increase by between 3% and 5% during the first quarter of 2014 and by mid-single digits during the full year. In addition, the company is forecasting gross margin to "improve significantly" versus 2013.

Industry context
Dillard's (NYSE: DDS  ) reported a similar increase of 2% in comparable-store sales during the 13 weeks ended in Feb. 1, while total merchandise sales increased 1% when adjusting for the extra week in 2012. Gross margin from retail operations declined by 180 basis points to 32.8% of sales, and adjusted net income fell by 6.3% to $2.69 per share.

Dillard's did not provide forward sales guidance, but margin pressure is clearly indicating the company is implementing big discounts in order to sustain sales in a harsh competitive environment.

Sears (NASDAQ: SHLD  ) reported a worrisome decline of $1.7 billion in sales during the quarter ended on Feb. 1, to $10.6 billion versus $12.3 billion in the same period of the prior year. Domestic comparable-store sales fell 6.4% during the quarter, comprised of decreases of 5.1% at Kmart and 7.8% at Sears Domestic. Things have been quite dismal for Sears in recent years, and there is no turnaround in sight, judging by its recent financial performance.

Macy's (NYSE: M  ) is a very different story, though. The company has been materially outperforming competitors over the last several years, and the latest earnings report was no exception. The company reported an increase of 2.3% in comparable sales, including departments licensed to third parties, during the 13 weeks ended on Feb. 1.

Gross margin came in at a strong 40.6% during the quarter, and adjusted net income per share increased by 13% versus the same period in the prior year. Macy's management is expecting an increase of between 2.5% and 3% in comparable sales during the first quarter of fiscal 2014.

Can J.C. Penney deliver?
CEO Mike Ullman is clearly doing a sound job after retaking the reins in April 2013, and he sounds optimistic about the prospects of a sustained turnaround in the coming years: "With the most challenging and expensive parts of the turnaround behind us, we will focus on improving gross margin, managing expense and steadily growing our sales in 2014."

If the company does in fact deliver according to management's guidance, performance could be roughly in line with that of Dillard's, doing materially better than Sears but not as well as Macy's. 

Under such a scenario, this should alleviate investors' concerns regarding financial risk at J.C. Penney. In addition, stabilizing sales performance could set the stage for improving profit margins in the long term, so J.C. Penney has a lot of room to run from current levels if the company continues moving in the right direction.

On the other hand, turnarounds are seldom easy, and the retail industry is a notoriously challenging business. Management does not have a lot of room for error considering the company's heavy debt burden, lack of profitability, and the harsh economic conditions affecting the industry.

Bottom line
J.C. Penney is clearly making material improvements, but the company is not out of the woods by any means. The good news is that the stock still offers substantial upside potential from current levels if management continues executing as expected. But make no mistake: J.C. Penney still represents a very risky proposition for investors.

A better proposition for investors
J.C. Penney offers substantial uspide potential, however, there's a huge difference between a good stock and a stock that can make you rich. The Motley Fool's chief investment officer has selected his No. 1 stock for 2014, and it's one of those stocks that could make you rich. You can find out which stock it is in the special free report "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.

Read/Post Comments (5) | Recommend This Article (1)

Comments from our Foolish Readers

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  • Report this Comment On March 04, 2014, at 8:55 PM, rrz174 wrote:

    you guys are amazing at saying nothing.. You are worse than the weatherman. Gee this stock could be a great choice...on the other hand, it may not..her come check out this marketing guys suck

  • Report this Comment On March 04, 2014, at 9:54 PM, Borisbmx wrote:

    garbage article

  • Report this Comment On March 05, 2014, at 3:49 AM, Roddy6667 wrote:

    I sold my JCP stock at $82, so I don't see an "explosion" at eight bucks. I see one foot in the grave and one foot on a banana peel.

    Same store sales are up 2% because of the stores that closed. Big whoop, 2 percent. And the company burns a couple of billion (with a B) dollars in cash every year and loses money across the board. I guess this is what passes as good news these days.

  • Report this Comment On March 05, 2014, at 8:30 AM, AHuston wrote:

    I say it is time to run. Already made my money trading this stock off the bottom. I want it to go back down to $5 a share so I can trade it again.

  • Report this Comment On March 05, 2014, at 12:18 PM, iamfool wrote:

    It is time to run. From Motley Fool. I don't think JCP will go back to $40 in the next month. But it will be in the teens or twenties. The repricing from bankruptcy to profit will not wait for next quarter's earnings. It will be priced in immediately.

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Andrés Cardenal

Andres Cardenal, CFA is a tenacious researcher of the best investment opportunities around the world. Andres is an economist and CFA Charterholder living in Buenos Aires, Argentina. Naturally flavored. Follow me on Twitter for more investment ideas:

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8/28/2015 4:02 PM
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