5 Things J.C. Penney Company's Management Wants You to Know

Sunny days ahead for the department store retailer.

A year ago analysts were debating how long it would be before J.C. Penney (NYSE: JCP  ) finally succumbed. The department store chain was issuing press releases denying media reports that its financing had been cut off, and the back-to-school season was seen as a last-ditch effort to save the company. If it couldn't generate sufficient sales, the writing was on the wall and investors could start looking for burial plots for the company.

Fast-forward 12 months and analysts were tripping over themselves during Penney's second-quarter conference call last week to heap superlatives on the remarkable performance it delivered. No longer a fluke or a one-off, the retailer is proving it's truly on a turnaround that is gaining traction.

Data: J.C. Penney SEC filings.

Penney posted quarterly revenue of $2.8 billion, a 5% increase from last year; though still recording net losses, at $172 million they're sharply narrower from 2013 when it saw well over $500 million in red ink.

Here are are five takeaways management thinks you should be particularly aware of going forward.

Sephora relationship continues to pay dividends
Filling in for CEO Myron Ullman, who was recovering from a surgical procedure, Penney Executive Vice President and CFO Edward Record said the retailer's exclusive arrangement with personal beauty care specialist Sephora continues to pay dividends.

Nearly half of Penney's 1,060 stores now feature a Sephora outlet. As it has rolled out boutiques to additional stores while expanding others, they continue to drive more customers in the door. Sephora revenues were up over 25% in total, but more important, rose 11% in stores opened at least one year.

Beauty may be in the eye of the beholder, but Sephora's ability to drive customer traffic is a thing of beauty for J.C. Penney.

The back-to-school season was a defining moment for Penney in 2013, and this year it represents an opportunity to cement the company's recovery. As Record highlighted during the conference call, "sales were strong during the final weeks of the (second) quarter, which represent the beginning of the critical back-to-school shopping season," and Sephora will be a key part of keeping the momentum going. 

Online sales will also be a key driver of more traffic
Traffic trends are still negative, and both Macy's (NYSE: M  ) and Kohl's (NYSE: KSS  ) have recorded similar difficulties, indicating an industrywide problem and not something specific to Penney. However, the company was able to show stronger numbers sequentially from the first quarter, and its omnichannel marketing strategy will be an important component of seeing those numbers turn positive.

Website traffic was up by double-digits for the quarter, improving 16.7% to $249 million. During the conference call, Record called the website "a cornerstone of our strategy" for recovering its standing with consumers.

Penney's online site skews heavily toward sales from its home department, which has been lagging. In fact, 30% to 40% of the online business is in home, compared to only 15% in the stores. With homewares still needing care and feeding, this could represent another big opportunity.

Just how big home could be
As sickly as the department has been, the in-store home business was up over 25% from the prior year and contributed roughly 200 basis points to the retailer's comp improvement. A lot of Penney's problem with home, however, was that much of what was being sold was clearance merchandise, particularly in furniture. Now J.C. Penney is focused on getting them to historical levels as a percentage of revenues, which portends improvements elsewhere on Penney's profit and loss. 

Home is where is the heart is, and where Penney's next growth spurt could come from. Photo: J.C. Penney.

The company a year ago began an overhaul of the home division, realizing the anchor it had become. As Record noted in the conference call: "Even in the months up against the relaunch, it comped positively. So we feel good about home." 

Margins continue to improve, and there's room for more growth
Because Penney significantly reduced clearance items from inventory -- a move separate from its restoration of the regular sales demanded by customers -- it was able to improve margins. 

Gross margin jumped 640 basis points in the quarter to 36% of sales as clearance items came in at less than 15% of the total sales. As that is in line with its historical averages -- Penney isn't looking for zero clearance, just typical run rates -- the retailer expects the trend to continue next quarter with a 650-basis-point improvement in gross margin.

It's a private affair with Penney's private label goods like J. Ferrar boosting margins. Photo: J.C. Penney.

Equally important as reducing its level of clearance goods has been the return of private label apparel such as St. John's Bay, JF, J. Ferrar, and Ambrielle. These lines not only give customers clothes within their budgets, but do so at margins that are 300 to 600 basis points higher than other brands, which is why Record said in the conference call that the "restoration of key private brands has been fundamental to our turnaround."

Private labels couldn't help the kids department
Despite the strength in Penney's partnership with Disney (NYSE: DIS  ) in the kids department, that segment remains well behind where it should be. There have been a lot of improvements made this year, but the benefits take time to become tangible. 

Record acknowledged that the team he had working in there was miserable at sourcing clothes and driving private label sales, but the department has been cleansed, hopefully in time for the Christmas season. The kickoff of back-to-school seems positive thus far, according to the CFO, "so we expect to see Q3 some of that impact and really to be in a decent place by the time we get to holiday in where we want to be in kids."

Foolish takeaway
Sales are up, margins are improving, losses are dwindling, customers keep coming back, and Penney is taking market share away from its rivals. A year ago analysts were biting their fingernails over its imminent demise, while today they're rightfully backslapping the executives who engineered this turnaround despite all the criticism and doomsaying.

Although there was some hefty optimism built into its stock price a year ago, which accounts for shares selling 30% below where they were back then, I'd say that just means this retailer today offers a superb discount to investors.

A company in turnaround mode is still a risk, and obviously not everything has gone as J.C. Penney has planned. But I'd hazard a guess that this once-venerable retailer is out of the woods at this point and that we'll continue to see it build on the gains that are now on the books.

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