J.C. Penney Investor Alert: The Most Important Question You Need to Ask

J.C. Penney (NYSE: JCP  ) has earned such adjectives as beleaguered and drowning over the past couple of years. However, it wasn't so long ago that the century-old chain was holding its own next to competitors Macy's (NYSE: M  ) and Nordstrom (NYSE: JWN  ) . What happened? J.C. Penney's management woes doomed the company's gross profit margin. Could J.C. Penney right that wrong in the near future? That is the question all J.C. Penney investors need to ask. Here's why.

Source: J.C. Penney

J.C. Penney's key problem ties into its promotional activities. Everyone loves a blowout sale -- except investors, especially if margins take a hit. Analyzing retail stocks can involve a wide range of metrics from comparable-store sales to consumer spending to inventory turnover. However, investors also need to look at how often a store relies on promotions and what that means for profit in the long term. This holds especially true in the fiercely competitive landscape of department stores that might also have inventory-turnover issues.

Are promotional activities a necessary evil that put Macy's and Nordstrom in a similar vice? Or does J.C. Penney have additional problems of its own?  

Calculating gross profit margins 
To understand J.C. Penney's problem, it's first important to know how to calculate the underlying metric. 

To calculate gross profit, subtract cost of goods sold, or COGS, from revenue. Take the answer from that equation and divide by the company's revenue then multiply the result by 100 to form a percentage and that's the gross profit margin. The gross profit margin shows the amount of profit per $1 of product sold after all of the costs of the sale are stripped away.

A higher profit margin leaves enough money around to trickle down as net income. A lower profit margin can come to negatively offset metrics such as comps and revenue growth. 

Companies disclose their final gross profit margins in their earnings releases. Find those numbers and compare them between companies in the same industry to get a better idea of a particular business's potential profitability.   

So which department store has the best profit margin? 

Macy's has the highest profit margin 
Here's a look at the quarterly gross profit margins of the three department store chains over the past five years. 

JCP Gross Profit Margin (Quarterly) Chart

JCP Gross Profit Margin (Quarterly) data by YCharts

Five years ago, the gross profit margin lines for the stores were all bumping into each other. Macy's and Nordstrom have continued to show this trend as J.C. Penney took a steep dive downward. 

Why has Macy's stayed mostly on top of Nordstrom? Macy's has higher revenue because it has more stores -- and that lead is significant enough to offset the company's inventory outstanding problem. The company reported nearly $28 billion in sales during 2013 and it operates over 800 stores. Nordstrom took in $12.2 billion of revenue in 2013 with 260 physical stores.

Where does J.C. Penney fall in this mix? 

J.C. Penney's the biggest loser 
Why did J.C. Penney's profit margin take the downward path? Let's take a side-by-side look at the company's revenue and COGS growth.

JCP Revenue (Quarterly) Chart

JCP Revenue (Quarterly) data by YCharts

The gap between COGS growth and revenue growth has grown in the past two years -- unfortunately in favor of COGS. What happened? 

This was the time-frame when Apple's Ron Johnson was brought in as a new CEO who was meant to completely reinvent the sagging, century-old chain. Johnson had big plans that included a stores-within-stores concept and those plans required some major inventory overhauls. J.C. Penney could've managed the rising inventory costs if revenue had gone along for the ride. However, customers turned away from Johnson's concepts -- and his attempted discontinuation of the chain's generous promotional events. So Johnson was let go and Myron "Mike" Ullman returned as CEO. 

Ullman had the unenviable task of fixing Johnson's changes in midstream. J.C. Penney was forced to use steep markdowns to move the increased but unpopular inventory that wouldn't move off shelves otherwise. However, Ullman promised that the excess inventory would clear out before the spring and that was supported by the company's latest earnings release.

Now J.C. Penney has to carefully find its footing. Revenue needs to improve but that's going to require more short-term costs in carefully selected inventory and strategic promotional events. J.C. Penney has to stick with the promotions since the company has a long track record of offering coupons and sales events. However, it's vital that the company comes back to balancing those promotions with revenue-boosting inventory. 

Foolish final thoughts 
Gross profit margin helps investors differentiate between competitors in the same industry -- but only when investors check the details. Macy's only beats Nordstrom because of its size as the latter is actually the more secure company. J.C. Penney has only run into serious problems in the past couple of years, but now it has moved into an important rebalancing period that could push its margins back up toward those of its competitors.  

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 30, 2014, at 9:36 AM, shawnisi wrote:

    Stating the obvious not to say the repeated. I need a job, I can do better than this.

  • Report this Comment On May 01, 2014, at 7:35 AM, longjcptoppick wrote:

    i also agree that JCP will catch M, WMT, TGT from here this year.. top pick JCP... $22.50 COMING JCP

  • Report this Comment On May 01, 2014, at 7:38 AM, longjcptoppick wrote:

    J.C. Penney: Volatility Is Your Friend, Strong Buy On Any Pullback

    Apr. 29, 2014 11:08 AM ET | 31 comments | About: JCP, Includes: PVH

    Disclosure: I am long JCP. (More...)

    Summary

    J.C. Penney remains a classic turnaround play with substantial upside potential.

    Security prices of turnaround companies are largely driven by psychological factors.

    Once investors love retail stocks again: Think about selling, not now.

    Volatility is a good thing for opportunistic investors. Falling share prices are mostly seen as a sign that a business faces serious problems or that a company disappointed on the earnings front. Warren Buffett, however, sees things a little different: He advises investors -- and this is the quote I read and hear the most -- to be "greedy when others are fearful and fearful when others are greedy." Naturally, considering the investing success and sound investing principles of the most successful investor in the world, I like to apply Warren Buffett's investment advice rather than listen to the activity-inducing 'stock tips' from CNBC or any other financial media outlet that appeals to the mainstream investor.

    Over the years, I have gravitated to a value investing/special situation philosophy which, at least for me, produced the best investment results: Buy low and sell High, keep your portfolio turnover low (heavy trading leads to empty pockets), buy a stock when others hate it, sell a stock when others love it. It is also an investing philosophy that requires investors to display emotional strength, to buy when many people will scream at you and, likely, ridicule you.

    Unfortunately, many investors lack the ability to look optimistically into the future and to be a visionary. When a company goes through changes and experiences operational/financial setbacks, too often financial commentators and analysts will descend on the company and rip it apart. And it is too easy to do so: If everybody bashes a company, why not join in and reduce reputational risk by aligning with the consensus opinion (also called the regret aversion bias)? However, kicking somebody that is already lying on the ground is not an accomplishment.

    J.C. Penney (JCP) is such a company. Many of J.C. Penney's problems have been much publicized with regard to eroding sales and negative comparable store sales growth rates. Last quarter, J.C. Penney has presented encouraging sales figures and caused some serious cognitive dissonance for exactly the investor crowd described above: Impatient, short-term oriented traders with nothing more on their mind than the next quarterly earnings. I don't believe businesses should or can be run with such a short-term mindset and I think many investors set themselves up to fail with that attitude.

    J.C. Penney still has a long way to go, no doubt about it, but it increasingly looks like that the embattled retail company is pulling its cart out of the ditch. Yesterday, J.C. Penney shares soared once again after positive news came out of the retail sector which suggest that J.C. Penney has a good shot at sustaining sales momentum in the coming quarters and present solid results to a mostly negative investor community (Source: theflyonthewall.com):

    Shares of retailer J.C. Penney are rising after apparel maker PVH Corporation (PVH) stated at a conference that it feels its business at J.C. Penney is strong and running "ahead of time." PVH's portfolio of brands includes Calvin Klein, Tommy Hilfiger, Van Heusen, and Izod. WHAT'S NEW: During its presentation at a retail conference hosted by Nomura earlier today, PVH's Chairman and CEO Manny Chirico said that the company's business is "pretty strong" right now at J.C. Penney and is "running ahead of plan." He said that in the dress furnishings inventory, the retailer has inventory levels back to where they "should have been." Chirico also said the company's Van Heusen and Izod sportswear business are "very strong" at J.C. Penney and they have also been running ahead of plan there. He said that based on the trends that PVH saw on the Men's side of the business, those brands seem to be performing at a much higher level. While Chirico said he can't make a broad statement, he believes the company's business is comping positively. The CEO added that he expects more positive results from its brands at J.C. Penney and the company is encouraged by everything it has seen over the last 4 to 5 months at the retailer.

    Retailers will bounce back

    I think there is a good chance that retail companies will be favored investments among investors who pursue sector rotation strategies a couple of quarters down the road. Once investors love retail stocks again, which I am sure will happen if history repeats itself (which it will), current J.C. Penney shareholders should think about selling their stocks, but probably not now. Even if 8-9% day gains are appealing and tempt investors to trade, I think the majority of capital gains will accrue slowly over a period of one to three years.

    Technical picture

    Conclusion

    J.C. Penney is a turnaround investment with substantial upside potential if the company can sustain its sales momentum and surprise investors. In the process, J.C. Penney will likely redefine investor perceptions, which should lead to earnings estimate upward revisions in the near term. With increasingly upbeat news out of the retail sector and improvements in consumer spending, J.C. Penney actually faces a set of powerful catalysts that could drive its share price much higher than the $8-9 we see now. I expect J.C. Penney to be very volatile in the short term, especially around earnings and comp release dates, but think J.C. Penney is only in the first inning of a comprehensive turnaround. Strong, long-term BUY, especially on pullbacks. I also have at price target on J.C Penny at $22.50 with this coming better than expected est coming.

  • Report this Comment On May 01, 2014, at 7:38 AM, longjcptoppick wrote:

    J.C. Penney: Volatility Is Your Friend, Strong Buy On Any Pullback

    Apr. 29, 2014 11:08 AM ET | 31 comments | About: JCP, Includes: PVH

    Disclosure: I am long JCP. (More...)

    Summary

    J.C. Penney remains a classic turnaround play with substantial upside potential.

    Security prices of turnaround companies are largely driven by psychological factors.

    Once investors love retail stocks again: Think about selling, not now.

    Volatility is a good thing for opportunistic investors. Falling share prices are mostly seen as a sign that a business faces serious problems or that a company disappointed on the earnings front. Warren Buffett, however, sees things a little different: He advises investors -- and this is the quote I read and hear the most -- to be "greedy when others are fearful and fearful when others are greedy." Naturally, considering the investing success and sound investing principles of the most successful investor in the world, I like to apply Warren Buffett's investment advice rather than listen to the activity-inducing 'stock tips' from CNBC or any other financial media outlet that appeals to the mainstream investor.

    Over the years, I have gravitated to a value investing/special situation philosophy which, at least for me, produced the best investment results: Buy low and sell High, keep your portfolio turnover low (heavy trading leads to empty pockets), buy a stock when others hate it, sell a stock when others love it. It is also an investing philosophy that requires investors to display emotional strength, to buy when many people will scream at you and, likely, ridicule you.

    Unfortunately, many investors lack the ability to look optimistically into the future and to be a visionary. When a company goes through changes and experiences operational/financial setbacks, too often financial commentators and analysts will descend on the company and rip it apart. And it is too easy to do so: If everybody bashes a company, why not join in and reduce reputational risk by aligning with the consensus opinion (also called the regret aversion bias)? However, kicking somebody that is already lying on the ground is not an accomplishment.

    J.C. Penney (JCP) is such a company. Many of J.C. Penney's problems have been much publicized with regard to eroding sales and negative comparable store sales growth rates. Last quarter, J.C. Penney has presented encouraging sales figures and caused some serious cognitive dissonance for exactly the investor crowd described above: Impatient, short-term oriented traders with nothing more on their mind than the next quarterly earnings. I don't believe businesses should or can be run with such a short-term mindset and I think many investors set themselves up to fail with that attitude.

    J.C. Penney still has a long way to go, no doubt about it, but it increasingly looks like that the embattled retail company is pulling its cart out of the ditch. Yesterday, J.C. Penney shares soared once again after positive news came out of the retail sector which suggest that J.C. Penney has a good shot at sustaining sales momentum in the coming quarters and present solid results to a mostly negative investor community (Source: theflyonthewall.com):

    Shares of retailer J.C. Penney are rising after apparel maker PVH Corporation (PVH) stated at a conference that it feels its business at J.C. Penney is strong and running "ahead of time." PVH's portfolio of brands includes Calvin Klein, Tommy Hilfiger, Van Heusen, and Izod. WHAT'S NEW: During its presentation at a retail conference hosted by Nomura earlier today, PVH's Chairman and CEO Manny Chirico said that the company's business is "pretty strong" right now at J.C. Penney and is "running ahead of plan." He said that in the dress furnishings inventory, the retailer has inventory levels back to where they "should have been." Chirico also said the company's Van Heusen and Izod sportswear business are "very strong" at J.C. Penney and they have also been running ahead of plan there. He said that based on the trends that PVH saw on the Men's side of the business, those brands seem to be performing at a much higher level. While Chirico said he can't make a broad statement, he believes the company's business is comping positively. The CEO added that he expects more positive results from its brands at J.C. Penney and the company is encouraged by everything it has seen over the last 4 to 5 months at the retailer.

    Retailers will bounce back

    I think there is a good chance that retail companies will be favored investments among investors who pursue sector rotation strategies a couple of quarters down the road. Once investors love retail stocks again, which I am sure will happen if history repeats itself (which it will), current J.C. Penney shareholders should think about selling their stocks, but probably not now. Even if 8-9% day gains are appealing and tempt investors to trade, I think the majority of capital gains will accrue slowly over a period of one to three years.

    Technical picture

    Conclusion

    J.C. Penney is a turnaround investment with substantial upside potential if the company can sustain its sales momentum and surprise investors. In the process, J.C. Penney will likely redefine investor perceptions, which should lead to earnings estimate upward revisions in the near term. With increasingly upbeat news out of the retail sector and improvements in consumer spending, J.C. Penney actually faces a set of powerful catalysts that could drive its share price much higher than the $8-9 we see now. I expect J.C. Penney to be very volatile in the short term, especially around earnings and comp release dates, but think J.C. Penney is only in the first inning of a comprehensive turnaround. Strong, long-term BUY, especially on pullbacks. I also have at price target on J.C Penny at $22.50 with this coming better than expected est coming.

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