Check out the latest J.C. Penney earnings call transcript.
U.S. retail sales grew 5.1% during the holiday season, the strongest growth in six years, according to Mastercard SpendingPulse. Apparel sales were a standout with 7.9% growth, the best performance for the category since 2010.
Department store J.C. Penney (JCP +0.00%) completely missed out on this prolific consumer spending. In the nine-week period ending Jan. 5, the retailer suffered a 3.5% drop in comparable-store sales on a shifted basis. Unadjusted for the calendar, comparable sales tumbled 5.4%. That's much worse than the 1.3% sales decline for the department store sector during the holidays, especially considering that decline was partly due to store closings.
If J.C. Penney can't succeed when the floodgates of consumer spending are wide open, there's not much hope for the iconic retailer.
Image source: Getty Images.
Slashing inventory and closing stores
J.C. Penney has an inventory problem. The company has talked in the past about having too much slow-moving merchandise in the stores, and new CEO Jill Soltau counts fixing this issue as a top priority. "As I walk our stores, we are over-assorted and heavy on inventory and we have a clear opportunity to provide an enhanced shopping experience for our customers," Soltau said during the company's earnings call in November.
J.C. Penney expects to have reduced its inventory by $225 million, or 8%, by the end of the fiscal year. The company is also planning to close three stores in the next few months as part of its ongoing evaluation of its store portfolio.
This merchandising failure is one reason why J.C. Penney's holiday sales were weak. The only way to get rid of inventory that no one wants is through heavy discounting, and that no doubt weighed on holiday sales. But excess inventory isn't the only problem. J.C. Penney likely suffered a decline in store traffic as well. If store traffic grew, the company would have almost certainly presented it along with its holiday sales results as a silver lining.
J.C. Penney may simply be past the point of no return. No matter what it does, consumers who have abandoned the stores are unlikely to even consider coming back. Losing a customer is easy. Winning a customer is hard. Winning back a lost customer is even harder. The J.C. Penney brand has suffered some serious damage over the past decade. It may be irreparable.
A dubious silver lining
One piece of ostensibly good news that came with J.C. Penney's holiday sales update was a reiteration of the company's expectation to produce positive free cash flow in fiscal 2018. Given the retailer's $4.3 billion of debt and roughly $300 million of annual interest payments, positive free cash flow makes the whole situation seem a lot less dire.
But that free cash flow comes with some major caveats. J.C. Penney's inventory reduction provides a temporary boost to free cash flow that can only be repeated as long as the company can keep reducing inventory. The retailer expects to be finished with its inventory reduction initiative by the end of fiscal 2019.
J.C. Penney has also been selling off assets, and the company conveniently includes the sale of operating assets in its free cash flow calculation. This boosted free cash flow by $132 million in the first nine months of 2018. Further asset sales are likely, but the company will eventually run out of stuff to sell. The Sears strategy only works for so long.
While J.C. Penney will report positive free cash flow for the year, the retail operation itself is not cash flow positive. And given the terrible holiday performance, it's hard to see that changing anytime soon. J.C. Penney is struggling during the best of times. If the economy turns sour, it may be game over.
