J.C. Penney's (JCPN.Q) third-quarter earnings report contained more alarm bells for investors. Though Sears Holdings (SHLDQ) beat it in the race to the bottom, the surviving department store chain is increasingly looking like its bankrupt rival.
New CEO Jill Soltau whistled past the graveyard in her comments, accentuating the positive parts of the business even though net sales fell 5.8% on a 5.4% decline in comparable-store sales. Considering that Macy's (M -2.68%) Q3 comps rose 3.3%, and it boosted its holiday earnings forecast -- it now expects comps to come in 2.3% to 2.5% higher than the year-ago period, with earnings in the $4.10 to $4.30 per share range, also 4% higher than prior guidance -- J.C. Penney is looking sickly.
Image source: J.C. Penney.
Not all the wheels have come off
J.C. Penney's management is concentrating on niche areas of the business that did well recently, such as women's apparel, activewear, big-and-tall men's clothes, and jewelry. That's similar to the strategy Sears took when it put most of its energy into mattresses and appliances, going even so far as to open stores dedicated to those categories.
Certainly a company has to play to its strengths, and women's clothing is a large part of J.C. Penney's business, providing a quarter of total sales. Comparable sales were up on a two-year basis, though they were flat year over year.
Men's clothes is another key J.C. Penney segment, accounting for 21% of total sales, but the "special sizes" category that it will emphasize has to be a much smaller subset, and though the business rose 15% in the quarter, how much revenue growth it can deliver overall is unclear.
Similarly jewelry accounts for just 5% of sales, so even if the retailer boosts sales in all these areas, it's not really going to change its trajectory. There's probably a lot more wiggle room in J.C. Penney's key businesses -- particularly in women's clothes -- than in the segments Sears was targeting, but the parallels between the two are becoming more stark.
Carrying a lot of baggage
J.C. Penney closed 140 stores last year, but even the 860 or so that remain amount to too many locations. Sears had more than 1,200 stores at the end, despite having closed hundreds beforehand and having more on the chopping block. While a healthy real-world footprint is important for these chains to drive sales, all that real estate has become a heavy burden for the retailer, and it likely needs to carve off even more.
It also had too much inventory, which forced it to run through a merchandise liquidation process to get it down to more manageable levels -- a move that was partly responsible for gross margins tumbling 280 basis points year over year.
Nor was that the first time in recent days J.C. Penney has resorted to big clearance sales to clear out stock: A year ago, it had to liquidate much of its women's apparel en route to revamping the line. While that may have help boost the department this time around, the perpetual cycle of discounting reveals deeper issues.
One area of concern is the balance sheet -- the retailer has $4.16 billion in long-term debt on the books, and only $168 million in cash and equivalents. Macy's, by comparison has $5.6 billion in debt and $736 million in cash and equivalents, but has shaved over $828 million from its debt balances over the past year. J.C. Penney's debt actually rose from last year. Rival Kohl's (KSS 1.49%) is even better situated. It's long-term debt stands at less than $2.3 billion while it holds over $1 billion in cash and equivalents.
Glimmers of hope
J.C. Penney does have a few things working its favor that Sears did not. First is that it still expects to be free cash flow positive at the end of the year, which gives it some financial breathing room. Second, its management is willing to take a proactive moves to stem its decline. Sears' longtime Chairman and CEO Eddie Lampert refused to even invest in his stores to update them until it was too late.
That doesn't change the fact that J.C. Penney's numbers are heading in the wrong direction at the most important time of the retail year, and that it doesn't expect the holiday season to materially help it. Its leaders may be pointing toward trends that could serve as the basis for renewal, but the company's new CEO doesn't have much time to get it right. And there's no margin of error if she and her team stumble.
