Less than a year ago, J.C. Penney (JCPN.Q) seemed to be getting its turnaround back on track. The company posted a solid 2.6% comp sales increase in the fourth quarter of fiscal 2017 and beat analysts' earnings estimates. It also projected modest comp sales growth and a slight profit for fiscal 2018 -- and, more importantly, solid free cash flow.
However, J.C. Penney's results have gone downhill quickly over the past year, leading to multiple guidance cuts. Furthermore, CEO Marvin Ellison and many of his top lieutenants resigned during the year. While J.C. Penney hired Jill Soltau as its new permanent CEO in October, the company still needs to fill numerous key management positions.
This has ignited a slew of speculation -- most recently from The Wall Street Journal (subscription required) -- about whether J.C. Penney is following quickly behind Sears Holdings (SHLDQ) on the road to bankruptcy. But while J.C. Penney is clearly struggling, it's misleading to compare it to Sears right now.
The headline numbers are discouraging
Through the first three quarters of fiscal 2018, comparable store sales declined 1.7% at J.C. Penney. The pace of decline accelerated in the second half of the year -- partly due to tougher comparisons -- which will cause comp sales to decline as much as 3% on a full-year basis.
J.C. Penney's sales trends worsened in the second half of 2018. Image source: J.C. Penney.
J.C. Penney also withdrew its full-year earnings-per-share guidance (which had already called for a big loss) at the time of its third-quarter earnings report. Finally, while the company still expects to post positive free cash flow for fiscal 2018, it won't come close to its initial forecast for $200 million to $300 million of free cash flow.
Management sees some straightforward fixes
Analysts currently expect J.C. Penney's full-year loss to reach $0.99 per share in fiscal 2018. That would translate to a little more than $300 million. While that would be a poor result, it can't come close to the multiyear string of $1 billion-plus losses posted by Sears Holdings recently.
Furthermore, J.C. Penney doesn't need to completely reinvent itself to get back to breakeven. As management discussed on the company's Q3 earnings call, high shrink rates -- write-offs of merchandise that is stolen or lost -- and unusually large clearance markdowns undermined gross margin in fiscal 2018. J.C. Penney is already working to crack down on shrink. Meanwhile, it is significantly reducing inventory levels to boost clearance margins.
Together, these two changes could improve earnings by hundreds of millions of dollars annually, getting J.C. Penney back to around breakeven. Improvements to the company's merchandise assortment and better use of pricing analytics could unlock further gross margin upside.
There's no liquidity crunch
Another key difference between Sears Holdings and J.C. Penney is that Sears was teetering on the verge of a cash crunch for years. The same can't be said for J.C. Penney, which had $1.9 billion of liquidity (including cash and availability through its credit facility) at the end of Q3 and is on track to end the fiscal year with more than $2 billion of liquidity. For comparison, liquidity was down to just $353 million by the end of fiscal 2017 at Sears Holdings.
After refinancing some of its debt last year, J.C. Penney has modest near-term debt maturities. The company has $50 million maturing in fiscal 2019 and $110 million maturing in fiscal 2020.
Even if J.C. Penney's core operations don't return to profitability immediately, the company may be able to cover those maturities with free cash flow generated from a combination of asset sales and inventory reductions. In a worst-case scenario, J.C. Penney could borrow from its credit facility to refinance the $160 million that is coming due in the next two years.
Image source: J.C. Penney.
J.C. Penney's credit facility and the vast majority of its roughly $4 billion of debt mature in the 2022-2023 period. That gives the company at least a three-year window to turn things around.
The problems are long term in nature
Ultimately, without a return to comp sales growth, J.C. Penney would eventually start burning cash and fall into a death spiral like Sears Holdings did. Whether new CEO Jill Soltau can get sales growing again is an open question -- and the combination of declining mall traffic and rising competition from off-price, fast-fashion, and e-commerce retailers will complicate any turnaround effort.
That said, whereas Sears Holdings has been in an almost-constant state of crisis in recent years, J.C. Penney doesn't face any major short-term threats to its existence. The iconic department store operator certainly needs to find ways to acquire new customers and reconnect with lapsed customers. However, it can afford to spend most of 2019 testing and perfecting new strategies before kicking its turnaround effort into high gear later this year or in 2020.
Check out the latest J.C. Penney earnings call transcript.
