Turnarounds can be risky and complicated, but they can also be enormously profitable for investors making the right bets on companies on the way to recovery. Let's take a look at three notable turnaround candidates, J.C. Penney (JCPN.Q), Best Buy (BBY -0.81%), and Rite Aid (RAD 24.00%), and try to find out which one could be the best purchase for your portfolio.
How real is J.C. Penney's comeback?
J.C. Penney was trading in the area of $6 per share in the last days of February, and the stock has made an impressive move since then. Even after a recent pullback, J.C. Penney is still trading in the area of $7.80 per share, an increase of more than 28% in a relatively short period of time.
Source: J.C. Penney.
The company announced better-than-expected earnings for the full quarter and year ending in Feb. 1, and that seems to be one of the biggest reasons for optimism among investors. Excluding the 53rd week in 2012, total sales during the quarter increased by 1.6% to $3.78 billion, and comparable-store sales grew by 2% versus the same period of the prior year.
Stabilizing sales is a valid reason for optimism, but it's important to note that J.C Penney had previously announced a big increase of 10.1% in comparable-store sales during November, so the 2% overall increase for the November to January quarter suggests considerable declines during December and January.
J.C. Penney provided fairly optimistic expectations for the medium term: Management is forecasting comparable-store sales to increase between 3% and 5% during the first quarter of fiscal 2014 and by mid-single digits during the full fiscal year. The company is also expecting gross margin to "improve significantly" versus 2013, both in the next quarter and through the full year.
If J.C. Penney can deliver in line with guidance in the coming quarters, then the possibilities of a sustained turnaround will look much more encouraging. At this stage, however, there are valid reasons to wonder if sales are really stabilizing, or if J.C. Penney simply delivered a short-term bounce in November.
Best Buy is fighting an uphill battle
Best Buy is implementing a transformation program in order to compete more effectively in the aggressively challenging electronics-retail industry. Unfortunately, operational efficiencies, pricing promotions, and customer engagement initiatives are not yielding the desired results so far.
Source: Best Buy.
During the quarter ending on Feb.1, Best Buy delivered a 1.8% decline in domestic revenue to $12.3 billion. Domestic comparable-store sales fell by 1.2% and comparable-store sales in international markets declined by 1.7% during the quarter.
Margins were also under pressure: Gross profit margin fell to 20% of sales versus 22.3% in the same quarter of the prior year.
The main bright spot in Best Buy's latest earnings report was the big increase of 25.8% in comparable online sales to $1.57 billion during the quarter. It's good to see Best Buy growing its online presence, but this is not compensating for the decline in physical stores' sales. Besides, if online is the name of the game, then Best Buy will be fighting an uphill battle against pure e-commerce players, which have structural cost advantages in that area.
Rite Aid is delivering healthy performance
Rite Aid has made considerable advancements via store-based restructuring, cost-efficiency programs, and an increased focus on health care over the last several quarters. CEO John Standley believes the company is moving beyond the turnaround phase and positioning itself for growth by capitalizing on the promising opportunities offered by the health care industry:
Because of our continued positive momentum, we are now in a position to evolve our strategy from one that focuses on turning our company around to one that emphasizes growth. And because of the rapid change taking place throughout the health care industry, we believe there are enormous opportunities to meet evolving marketplace needs, better serve our customers, and demonstrate our value to the health care system.
Source: Rite Aid.
Recent financial performance provides support for this point of view: Sales during the quarter ended on March 1 increased by 2.2% to $6.57 billion, while same-store sales grew 2.1% versus the prior year.
Importantly, forward guidance was particularly encouraging. Management expects sales to be between $26.0 billion and $26.5 billion in fiscal 2015, with same-store sales expected to increase between 2.5% and 4.5% over fiscal 2014.
Due to factors such as an aging population, broadening health care insurance coverage, and technological advancements in medicines and treatments, health care demand should remain strong over the long term, and this could be a big positive factor for investors in Rite Aid over the years to come.
Bottom line
J.C. Penney announced some positive sales trends during the last quarter, but it's not easy to tell at this stage if the company is really making a sustained turnaround. When it comes to Best Buy, results are just not there yet, so a position in the company is considerably risky.
Rite Aid, on the other hand, is delivering solid performance, and the company seems to be ready to move beyond stabilization and into growth over the coming quarters. In terms of risk versus reward, Rite Aid looks like the best alternative for investors.
