Last week, J.C. Penney (JCPN.Q) reported mediocre results for the final quarter of fiscal 2016. On the plus side, J.C. Penney eked out a full-year adjusted profit of $0.08 per share: its first annual adjusted profit since 2011. On the other hand, sales stagnated during 2016 after strong growth during the previous two years.
On balance, J.C. Penney had an unsatisfactory year in 2016, falling short on many aspects of its original financial guidance. Following the earnings report, J.C. Penney's top executives spent an hour talking with analysts about what went wrong and how they plan to fix it in 2017. Here are five of the most important points raised by management.
Unforced errors
In addition, store gross margin was negatively impacted by the actions we took in the quarter with couponing and increased promotional activity. ... [M]any of the Q4 decisions we made diluted gross margin while providing limited top-line sales. In retrospect, these were poor decisions that will not be repeated in the future.
-- CEO Marvin Ellison
Ellison was candid in acknowledging that J.C. Penney made several tactical missteps last quarter. Most notably, with sales falling short of targets, the company increased its coupon offers and other discounts in an attempt to recover. However, it didn't do so in a coordinated way, nor did it market its coupon offers effectively. This undermined gross margin without garnering much in the way of incremental sales.
Poor execution of discounting tactics hurt J.C. Penney in Q4. Image source: J.C. Penney.
In the past two years, Ellison has emphasized a data-driven approach to making decisions. Unfortunately, some J.C. Penney employees fell back into bad habits last quarter, relying more on intuition than data. Ellison has vowed that the company won't repeat these mistakes.
Women's apparel was a major weak spot
All apparel categories -- men's, kids, and women's -- performed below the company comp for the quarter, with men's and kids significantly outperforming our women's business.
-- Ellison
The women's apparel business is J.C. Penney's top product category, accounting for about a quarter of its sales. In total, apparel drives a little more than half of the company's revenue. Thus, it is hard for J.C. Penney to overcome weak results in this part of its business.
Unfortunately, J.C. Penney saw poor results in all segments of its apparel business during Q4. The women's section performed the worst, due to product missteps. Most notably, J.C. Penney still carries too much "career" clothing relative to casual items. The company is revamping its product assortment to improve performance in this area. It is also working to cut lead times for private-label clothing by 40%, in order to better respond to style trends in the future.
Cash flow disappoints but should bounce back
While we were disappointed in our free cash flow of $3 million we are pleased to have produced positive cash flow in a tough environment. In addition, we expect to generate between $300 million and $400 million in free cash flow in 2017.
-- CFO Ed Record
As recently as November, J.C. Penney expected to increase its free cash flow in 2016 relative to the $131 million of free cash flow it generated in 2015. However, weaker-than-expected profitability and unfavorable changes in working capital prevented it from achieving this goal.
However, J.C. Penney is well positioned for better performance in 2017. The company plans to reduce its inventory this year, driven in part by its plan to close 130-140 stores by June. It also expects to get a benefit of roughly $100 million from asset sales. This should allow J.C. Penney to produce solid free cash flow of $300 million-$400 million during 2017.
The appliance rollout remains a key priority
Appliance sales both in-store and online continue to drive significant comp growth and improve productivity in our home store. We plan to leverage this performance by opening approximately 100 new appliance showrooms in early 2017 and adding new brand partners to our showrooms throughout 2017.
-- Ellison
Due in part to the volatility of the apparel business -- along with broader consumer trends -- J.C. Penney has been trying to reemphasize its home business. Its biggest initiative in that regard is the company's return to the major appliance market. During 2016, J.C. Penney went from a standing start to selling appliances in more than 500 stores and online.
J.C. Penney added appliance showrooms in more than 500 stores last year. Image source: J.C. Penney.
The move into appliances has been successful thus far, allowing J.C. Penney to make better use of previously unproductive floor space. However, it's still early. In 2017, J.C. Penney aims to gain momentum in this new product category by adding new brands and opening appliance showrooms in about 100 additional stores.
Still looking for new product categories
We had toys in our assortment this holiday season for the first time in many years and the response was excellent. Based on these results we will continue to offer toys in 100 stores during the first half of 2017 and will significantly expand the toy assortment in all stores for back-to-school this year.
-- Ellison
While returning to the appliance business was a prominent strategy shift, J.C. Penney is still looking to add other new product categories that its customers are interested in. During the holiday season, it successfully experimented with carrying toys in its stores. As a result, the company plans to carry toys year-round in at least some of its stores going forward.
J.C. Penney has other tests planned for 2017. Recognizing that its core customers own their homes, it recently partnered with Trane to offer installation of heating and air conditioning systems through some of its stores. It also began testing partnerships with Ashley Furniture (for furniture) and Empire Today (for flooring) last year.
J.C. Penney still has a lot of work ahead to complete its turnaround. But at least it has clear initiatives in place to get apparel sales back on track while also diversifying into other product categories. These initiatives give it a good chance of bouncing back in 2017
