Last Friday, J.C. Penney (JCPN.Q) reported that comparable-store sales fell 3.5% in the first quarter, in line with other department stores' trends. While profitability improved somewhat -- especially if you include a $111 million asset sale gain -- investors were not pleased. J.C. Penney shares have fallen 24% in less than a week.
Nevertheless, J.C. Penney's management remains confident that the company will be able to hit its full-year guidance for 2017 and drive further earnings growth in future years. Here are five important reasons for optimism that J.C. Penney executives cited on the first-quarter earnings call.
New areas of focus are growing
Even in the face of [a] difficult top line for the first quarter, our new growth initiatives delivered another quarter of strong performance and positive comps, particularly appliances, in-home custom window, mattresses, furniture, Sephora, Salon, activewear, and fine jewelry.
-- J.C. Penney CEO Marvin Ellison
Apparel currently accounts for more than half of J.C. Penney's revenue. Thus, when the company's apparel sales started to decline last year, it put huge pressure on comp sales.
CEO Marvin Ellison has been driving J.C. Penney to diversify its business so that it won't be so dependent on apparel sales trends going forward. These efforts are working, although they haven't been sufficient to offset weakness in the apparel market yet.
For example, J.C. Penney's cosmetics partnership with Sephora and its new Salon by InStyle concept are both growing their revenue and driving more traffic to J.C. Penney stores. Meanwhile, several home-related initiatives are supporting strong growth in that department.
Women's apparel is turning the corner
Women's apparel also delivered the best comp trend improvement from Q4 of last year to Q1. Broadly speaking, we're pleased that our new apparel strategy, highlighting inspiring trends at a value, performed well in the casual and contemporary categories of women.
Apparel remained J.C. Penney's Achilles' heel last quarter. However, trends in the key women's-apparel business did improve relative to the fourth quarter. Furthermore, sales trends were better in the March-April period than in February, indicating that momentum is improving.
So far, customers seem to be responding to some recent product assortment changes that J.C. Penney has implemented. While management still doesn't expect positive comp sales performance in women's apparel this year, the declines should be less bad for the rest of 2017. The company may also be able to apply some "lessons learned" to men's and children's apparel.
Lower inventory will boost gross margin and cash flow
We are prudently managing our inventory levels and are pleased with the progress we've made this quarter. [W]e expect total inventory at the end of 2017 to be down at least 5% versus the end of 2016.
-- J.C. Penney CFO Ed Record
In the past couple of years, J.C. Penney has invested in new tools that should aid its inventory management. Inventory reduction is a key priority for this year after the apparel sales slowdown caused J.C. Penney to end 2016 with too much inventory. J.C. Penney aims to reduce its inventory by at least 5% this year, boosting its cash flow.
Some of the inventory reduction relates to the 138 stores J.C. Penney plans to close in 2017. However, this will be partially offset by strategic inventory investments in growth areas such as appliances and Sephora. The more important change is a planned reduction in apparel inventory, which should make J.C. Penney more nimble going forward, leading to better margin performance.
New technology will support future margin growth
So we are in the process right now of rolling out an intelligent orders sourcing logic capability. ... And so what this new system does is it actually has a real-time optimization functionality that looks at speed. It looks at delivery expense. It looks at labor. It also looks at markdowns in terms of current markdowns and future markdown avoidance.
-- J.C. Penney Executive Vice President of Omnichannel Mike Amend
Six or seven years ago, J.C. Penney was fairly strong in e-commerce. However, it fell way behind in 2012 and 2013 as former CEO Ron Johnson put all of his energy into reinventing the company's stores. J.C. Penney has been playing catch-up ever since.
J.C. Penney is just now getting back on a level playing field in terms of "omnichannel" capabilities. By later this year, it will be able to fulfill online orders out of any store, as well as from dedicated fulfillment centers. This ability, along with some new technology, should help J.C. Penney boost its e-commerce sales while driving down costs and optimizing inventory levels across stores and fulfillment centers.
Debt reduction will boost profitability
I didn't mention in my prepared remarks, but we've taken $1.4 billion [of] debt out at the completion of this tender over the last 3.5 years.
In the past two years, J.C. Penney has put a lot of effort into reducing its debt. During the first quarter, J.C. Penney paid off a $220 million debt maturity. This month, it launched a tender offer to retire another $300 million of debt. The company is actively looking at other potential asset sales that could allow it to pay down more debt in the next year or two.
This debt reduction is steadily driving down interest expense. Thus, it boosts J.C. Penney's future profitability regardless of its future performance. Lower debt levels also make the stock less risky for investors. If J.C. Penney can continue to improve its balance sheet in the next few years, the company's earnings multiple is likely to rise gradually.