During 2014 and 2015, troubled department store operator J.C. Penney (NYSE:JCP) made big strides to get back on its feet. After burning more than $2.7 billion of cash in 2013, J.C. Penney has rebounded to generate positive free cash flow since 2014.
J.C. Penney's earnings recovery has been supported by deep cost cuts and a return to sales growth. However, the company is running out of room to reduce costs further. Meanwhile, its sales growth stalled in 2016, putting its turnaround in jeopardy. Getting comparable-store sales growing again in 2017 is an absolute must.
Sales fall short -- again
In 2014, comparable-store sales grew 4.4% year over year at J.C. Penney, as customers started to return to its stores. The momentum continued in 2015, as comp sales rose another 4.5%.
However, J.C. Penney has run into trouble over the past year. It reported comp sales declines for two of the first three quarters of fiscal 2016. For the first nine months of the year as a whole, comparable-store sales increased a paltry 0.3%.
Some of this slowdown can be attributed to unfavorable weather and tough year-over-year comparisons. Other mall-based department store chains like Macy's (NYSE:M) and Sears Holdings (OTC:SHLDQ) are experiencing even bigger comp sales declines. That said, J.C. Penney is clearly suffering from the department store sector's broader malaise. Mall traffic has been plunging faster than department stores' online sales have been rising.
This trend continued during the holiday season. While J.C. Penney's management had been optimistic about returning to growth during Q4, the company announced earlier this month that comp sales slipped 0.8% year over year in the combined November-December period.
Can J.C. Penney reach its profitability goals?
J.C. Penney's sales performance over the past year has been quite good compared to competitors. However, while J.C. Penney is in much better shape than Sears, it's at a big disadvantage relative to Macy's and Kohl's in that it is far less profitable. In fact, the company hasn't earned a full-year profit since 2011, although it still may be able to post a modest adjusted profit for fiscal 2016.
During the past year, management has repeatedly stated that J.C. Penney has multiple pathways for growing earnings. If sales growth misses expectations, the company should be able to find offsetting cost cuts to reach its profitability goals. (For example, J.C. Penney has maintained its earnings guidance throughout the past year despite its disappointing sales performance.)
Nevertheless, it will be very challenging for J.C. Penney to maintain its earnings momentum with stagnant comparable-store sales. Cutting costs too far could trigger a vicious cycle of declining sales if it results in poorly maintained stores. (Just ask Sears!)
J.C. Penney still has a substantial debt load despite its debt reduction efforts of the past two years. As a result, it runs the risk of lurching from crisis to crisis if it can't get comparable-store sales growing again.
Rivals close stores -- will J.C. Penney follow?
There are two possible ways out of this conundrum for J.C. Penney. One possibility is that imminent store closures by other retailers such as Macy's and Sears help the company get comp sales growing again. Macy's is closing 63 stores in the next few months, while Sears Holdings will close 42 Sears stores and 108 Kmart stores this spring.
J.C. Penney's management has noted that store closures by rival department stores typically lead to higher sales at J.C. Penney stores in the same mall. Over the past year, J.C. Penney has deliberately positioned itself to gain sales at Sears' expense by adding appliance sections to about 500 stores.
That said, Macy's and Sears have both closed a number of stores in the past year. While those store closures may have helped J.C. Penney somewhat, the company's comp sales performance has still been unsatisfactory.
Thus, J.C. Penney executives have recently started thinking about closing stores again. While the company only has four unprofitable stores right now, it can sometimes make sense to close a marginally profitable store in order to free up capital to invest in better-performing locations. (It's also usually possible to retain some of the sales from a closed location either online or at other stores.)
For now, J.C. Penney is likely to close a relatively small number of underperforming stores. It can afford to give its ongoing sales growth initiatives another year to gain traction. However, if that doesn't work, J.C. Penney may have to follow rivals like Macy's and Sears by slashing its store count.