An ability to overcome economic and internal headwinds are among the primary concerns analysts have for J.C. Penney (JCPN.Q) being able to complete its transformation. An economic recovery that's left the majority of consumers behind hints at a tougher retail environment still in the months ahead, and last year's gains were achieved on an all-but-dead 2013. With air let out of the retailer's once soaring stock, investors are right to question whether now is the time to jump in.
Sales must accelerate
J.C. Penney recorded 3% sales growth in 2014, hitting $12.3 billion as comparable store sales rose 4.4% from the prior year. That's a remarkable achievement after many analysts expected the retailer was done for, but in investing it's not nearly enough to survive -- you have to thrive, too.
Even J.C. Penney's inadvertent slip that it's first quarter sales progress was better than what Wall Street was anticipating indicates sales aren't ramping up as fast as they need to. The department store's revenues may be ahead of last year, but they're still 30% below the level recorded just three years ago and are almost 40% below their peak in 2007.
No one expects J.C. Penney to reach $20 billion in annual sales anytime soon -- the retailer is simply looking to get to $14.3 billion within three years -- but revenue growth must still accelerate dramatically just to gain parity with where it was when the wheels fell off. It would have to grow sales at an annual compound rate of over 7% for five years to reach $17 billion in annual revenue. So management is admitting it's a very grow-slow pace it's keeping.
A heavy debt load
Holding it back will be the large amount of debt J.C. Penney carries. While it needed to leverage its balance sheet to get it through the holidays when cash was pinched, it now needs to think about how it's going to service the debt if sales don't accelerate.
The retailer's financial leverage, or the amount of assets it owns in comparison to the debt it owes, has skyrocketed in recent periods. Just like a homeowner that has more mortgage than house, the ability to pay the bill every month becomes increasingly difficult if income is compromised. J.C. Penney's rising sales help, but it will be like a juggler trying to keep all his balls in the air as it has many competing claims on those scarce dollars.
Front and center
The department store chain is looking to bolster sales further. It has established a foundation that it calls its center core, which consists of its fine jewelry department and the Sephora beauty care boutiques, two high-margin businesses.
J.C. Penney will be adding 25 additional Sephora inside JCPenney boutiques while expanding six existing shops this year. And fine jewelry repeated its performance as one of the retailer's top-performing businesses last year. Now that it's added the Modern Bride Signature Collection and the Diamond Vault, the retailer is looking forward to seeing these businesses pad their lead -- and profits.
Just don't expect immediate results. J.C. Penney has laid out a three-year $1.2 billion revenue growth road map, and center core expansion is part of it, but the plans laid out above won't begin to kick in till later this year and then grow from there across the rest of time frame.
Still, the tinkering it's already done has helped margins improve significantly. Gross margin rose by 540 basis points in 2014, hitting 34.8% of sales, while adjusted EBITDA (or earnings before interest, taxes, depreciation, and amortization) improved by nearly $900 million year over year, and it generated over $50 million in free cash flow, a $2.8 billion improvement over 2013.
A tricky read
J.C. Penney has a lot more levers it plans to pull to achieve its goals, including building out its omnichannel offerings by enhancing its online business, and has already improved sales and conversion online (or the ability to turn visitors -- whether in-store or online -- into buyers).
But macroeconomic winds change -- look at Greece, which once again looks like it's poised for collapse, an event that could cause a cascade effect that pulls the world back into recession. That would obviously have an impact on both consumer confidence and spending, and an attack on either would upend J.C. Penney's plans.
And that's the trouble with investing in turnarounds: You're always whistling past the graveyard hoping nothing disturbs the course it's set. The plan J.C. Penney has is a sound one, but it's fraught with risk and investors need to go in with their eyes wide open before taking the plunge and buying its stock.
