Retailer J.C. Penney has surmounted Wall Street doubts before. Can it do so yet again?
The story for J.C. Penney (JCPN.Q) has changed once more on Wall Street.
After analysts turned up their collective noses at the possibility the troubled retailer could stave off bankruptcy last year, the pros ended up championing its cause earlier this year after it proved them wrong by making dramatic changes that not only saw its stock price double in value, but actually do so by increasing sales and significantly reducing losses.
Now they're beating the drum of worry and doubt again, and though the change of heart can partly be blamed on J.C. Penney itself, Wall Street's lack of courage looks to be little more than a case of analysts having feet of clay. There's still a lot to be positive about, and with the loss of about a third of its value over the past month, I'll be putting my money where my mouth is and buying J.C. Penney's stock.
Warning signs ahead
Goldman Sachs (GS 0.22%) got the ball rolling last month suggesting that because the month of October remained a volatile month when it came to options trading, the market hadn't priced risk into J.C. Penney's options and it was best to buy protection. Credit Suisse (CS) followed with some prescient insight into being able to maintain its same store sales growth amid a host of challenges including not enough exposure to key retail segments (like handbags and accessories), an inability to leverage its balance sheet, and an unsustainable level of capital spending.
This investor thinks J.C. Penney still has growth in the bag. Photo: J.C. Penney Analyst Day 2014 presentation, Oct. 8, 2014.
Although those reports dented the gains the department store operator had made, it was J.C. Penney's seeming confirmation of the worst of those fears with its update that sent its shares tumbling.
The retailer had led everyone to believe the back-to-school season was off to a strong start and the quarter would end on a strong note. However, when it updated guidance it said the momentum it had gained leading up to the month of September dissipated quickly as schools opened for class. Where it had been forecasting mid-single-digit comps for the quarter, it was now saying they would be in the low-single digits. That suggested a lot of business quickly went away.
That also clanged the school bell for some investors that it was time to go away too, and shares that had already been pulling back shifted sharply lower. The stock closed 11% lower the day of J.C. Penney's analyst day update, fell another 7% each over the next two days, closing out the week down 22%. Although shares have gained back a few pennies of its losses, the stock remains depressed.
It's not all bad news
I still see lots of reasons to be hopeful. First, although J.C. Penney said comps would be lower this quarter, it still reiterated its guidance for margins and SG&A and reaffirmed the entirety of its full-year guidance, including comps coming in in the mid-single-digit comp range, and equally important, if not more so, it would be free cash flow positive for the year.
It also announced it would be tackling some of the key questions Credit Suisse analysts had. For example, J.C. Penney plans on remodeling its handbags and intimates departments and would be giving shoes 30% more floor space while also breaking out men's footwear into its own department.
These boots are made for walking all over analyst dire predictions. Photo: J.C. Penney Analyst Day 2014 presentation, Oct. 8, 2014.
The home department would also see more investment dedicated to its revitalization that would lead the division to gain some 30% of the $2.55 billion in sales growth it sees coming its way over the next three years.
In addition to the home department improvements, Penney plans to expand e-commerce -- it introduced a new mobile app and a mobile website redesign at the conference -- as well as tackling beauty, jewelry, and accessories. A further $1 billion in growth is seen coming from market share gains, not completely out of the realm of possibility as it has already been stealing share, most notably from Kohl's (KSS 1.49%), which has largely followed Penney's previous plan down the rat hole.
Every day is Christmas for retail
Economic turmoil is still in J.C. Penney's future, but also ahead of the competition too. Yet the National Retail Federation said it expects Christmas sales over this coming November and December to rise 4.1% to $616.9 billion from 2013's total, and its Shop.org division forecasts online shopping for the holidays will expand as much as 11% over last year, hitting $105 billion.
While there's some disagreement between the department store and Wall Street over what the right size of its national footprint should be -- analysts were looking for significant store closings to support the level of sales they believe it can generate; Penney said it was close to being in balance -- its growth initiatives seem to be the right ones needed.
Wall Street's frosty reception of J.C. Penney's guidance hasn't dampened the retailer's enthusiasm for the future. Photo: Flickr via Mike Mozart.
Its successful partnership with Sephora will be expanded, the one with Disney (DIS 0.16%) will be grown to see over 100 new boutiques added to its stores by the 2015 back-to-school season, and it will be experimenting with a Hallmark shop in a few stores this year with a larger rollout in in 2015.
Lots of profit still to be realized
Taken as a whole, these initiatives are seen as giving J.C. Penney an opportunity to generate $1.2 billion in EBITDA by 2017 and incrementally delivering $2.1 billion in sales.
Through this transition, newly appointed CEO Marvin Ellison, an individual with extensive operational experience, is expected to provide a steady hand on the company's tiller.
I think Wall Street is once again overreacting to the news, but the market's reaction provides an entry point we haven't seen since early on in the year (following similar "dire" results after last Christmas), and I plan on taking advantage of it. In fact, in compliance with The Fool's trading restrictions, I plan to open a position as soon as possible.
