So far, 2017 has been a terrible year for J.C. Penney (OTC:JCPN.Q) shareholders like myself. Wariness about the future of department stores and other brick-and-mortar retailers has turned into outright panic. J.C. Penney stock has plunged to new all-time lows this month, after the company reported a larger-than-expected second-quarter loss on Aug. 11.
That said, the second quarter was an unusual period, as J.C. Penney closed more than 100 stores at the end of July. On the earnings call, J.C. Penney executives explained why they believe that the company's turnaround is still on track. Here are five key points they emphasized.
Store closings hurt gross margin
Margin for the second quarter was 35.1% of sales, a decline of 200 basis points compared to the same period last year. While we expected margin to be down on a year-over-year basis due to the liquidation of inventory and our closing stores, the decline in our margin rate from these efforts was greater than we originally anticipated.
-- J.C. Penney Investor Relations Manager Trent Kruse
Under CEO Marvin Ellison, J.C. Penney has pursued gross margin expansion by investing in its private brands and improving its use of data to optimize pricing and inventory. Entering the second quarter, J.C. Penney had forecast that gross margin would increase by 0.2-0.4 percentage points for the full 2017 fiscal year.
However, gross margin fell by 2 percentage points on a year-over-year basis last quarter. As a result, J.C. Penney now expects that gross margin will decline by 0.3-0.5 percentage points year over year in fiscal 2017.
J.C. Penney executives took great pains to emphasize that last quarter's big gross margin decline was mainly caused by the liquidation sales at stores that the company closed. J.C. Penney's new full-year guidance implies that gross margin will be flat or up slightly for the rest of 2017.
Appliance sales will be key to future growth
Following the rollout of 100 new appliance showrooms in May and the success of our Memorial Day and Independence Day events, we saw ... almost 300 basis points of positive benefit this quarter from appliances.
-- J.C. Penney CEO Marvin Ellison
The appliance business will be one of J.C. Penney's most important growth drivers for the next few years. Appliances contributed almost 3 percentage points of comp sales growth in Q2, turning what would have otherwise been a disastrous quarter into a mediocre one.
Most of J.C. Penney's appliance sections were up and running by the end of last summer, so year-over-year comparisons for the appliances business will be tougher in the quarters ahead. But there is lots of room for further growth. First, J.C. Penney has added more appliance showrooms this year. Second, it is fine-tuning its marketing for appliances. Third, it is adding new brands, such as Frigidaire (which will arrive later this quarter).
The company expects stronger sales trends in the second half of 2017
But as we think about the second half of the year, I want to remind you that our easiest comparisons are in the second half, the third and fourth quarter. Our most difficult comparison was in the second quarter. ... And we mentioned in our earnings release and in the prepared comments that the very important back-to-school season is off to a good start.
While sales comparisons in the appliance department will be tougher going forward, J.C. Penney will face much-easier year-over-year comparisons overall. Whereas comp sales increased 2.2% in the second quarter of fiscal 2016, comp sales declined 0.8% and 0.7% in the third and fourth quarters, respectively.
If J.C. Penney's recent sales trend holds, these easier comparisons should allow it to return to comp sales growth this quarter. J.C. Penney also has a variety of strategic initiatives to drive growth, focusing on the beauty and home businesses, e-commerce, and new product categories.
Fixing the apparel business is crucial
Lastly, we continue to improve and strategically adjust our apparel categories with an emphasis on fixing our women's apparel business. In the past, JCPenney has been overassorted in traditional women's clothing and underassorted in casual and contemporary women's clothing.
While J.C. Penney is working hard to diversify, the company must fix its apparel business to produce meaningful sales growth. Apparel still accounts for more than half of J.C. Penney's sales, led by women's apparel at 24% of company revenue.
In the women's business, J.C. Penney is finally addressing the long-running preference shift toward more casual clothing. J.C. Penney has changed its inventory mix for the fall season -- reducing inventory of traditional work attire in favor of casual styles and activewear -- which should boost sales trends going forward. The company also hopes to continue its success in the special-size category.
The balance sheet is still improving
With the successful completion of this tender offer, we have now reduced our outstanding debt levels by well over $500 million since the start of this year. These combined actions resulted in $40 million of annual interest expense savings. We expect our 2017 net debt leverage ratio to be approximately 3 times by the end of the year.
While J.C. Penney's second-quarter profit fell short of expectations, the company still generated free cash flow of $303 million, helped by the liquidation of inventory in stores that have closed. This allowed the company to repurchase $300 million of debt due in 2018 and 2019 through a tender offer process.
J.C. Penney had already retired $220 million of maturing debt during the first quarter, using cash on hand. Thus, the company has significantly reduced its debt load this year, driving long-term interest savings. Furthermore, despite facing a tough start to the year, J.C. Penney is still on track to meet its near-term leverage target by the end of fiscal 2017.