J.C. Penney Still Can't Escape the Retail Apocalypse

J.C. Penney's (JCPN.Q) stock recently rose after the struggling retailer's third-quarter numbers surpassed analysts' expectations. Its total net sales fell 10% annually to $2.38 billion but still exceeded estimates by $70 million.

Its non-GAAP net loss narrowed year over year from $164 million to $97 million, or $0.30 per share, which also beat expectations by $0.24. Its adjusted EBITDA rose 130% to $106 million. On a GAAP basis, its net loss narrowed from $151 million to $93 million. Those bottom-line improvements were encouraging, but J.C. Penney's sliding revenue indicates that it's still in the shadow of the retail apocalypse.

Image source: J.C. Penney.

Another quarter of declining comps growth

J.C. Penney's comparable store sales dropped 9.3% during the quarter, marking its fifth straight quarter of negative comps growth. On an adjusted basis, which excludes the impact of its exit from the major appliance and in-store furniture categories, its comps still fell 6.6%.

Source: J.C. Penney quarterly reports. *Adjusted basis.

It attributed those declines to reduced transactions, which were only partly offset by higher transaction values. It also faced a tough comparison to the prior-year quarter, when the aggressive liquidation of its excess inventory buoyed its top line growth.

It stated that its top merchandise categories included fine jewelry, footwear, and apparel (especially in denim, athletic, and private-label brands) during the quarter, but none of those categories meaningfully boosted its total comps growth. Simply put, J.C. Penney is still struggling to undo the years of damage caused by dying malls, poor management, and escalating competition from e-tailers and superstores.

Focusing on cost-cutting measures instead

CEO Jill Soltau, who took the helm a year ago, claimed that the retailer's "Plan for Renewal" turnaround initiative was reaping early results -- but she still expects the company's comps to fall 7% to 8% (or 5% to 6% after excluding the appliance and in-store furniture divisions) for the full year.

The "Plan for Renewal" focuses on liquidating J.C. Penney's excess inventory, quitting lower-margin markets, right-sizing its stores with more appealing products, closing weaker stores, and improving the margins of its non-clearance products. It's already accomplishing some of those goals.

Its inventory declined 9% annually to $2.93 billion during the quarter. Its cost of goods sold came in at 64.6% of its sales, down from 68.1% a year ago, thanks to higher store and online selling margins, a lower shrink rate (its percentage of unaccounted inventory), and its exits from the major appliance and in-store furniture markets. It also announced that it would close nearly 30 stores earlier this year, but it still operated approximately 850 locations at the end of the quarter.

Image source: J.C. Penney.

Narrower losses and a slight dent in debt

Those cost-cutting moves narrowed J.C. Penney's net losses during the quarter, but it still generated negative free cash flow of $518 million over the past nine months -- continuing the trend from the same period last year when negative free cash flow hit $500 million. Its cash and equivalents balance also fell 7% annually to $157 million.

Nonetheless, J.C. Penney still expects its free cash flow to turn positive by the end of 2019 as it clears out more inventory and reduces its cost of goods sold. It also reduced its long-term debt 4% annually to $4.01 billion -- which indicates that it remains focused on taming its debt.

J.C. Penney also raised its adjusted EBITDA guidance from a range of $440 to $475 million to over $475 million for the full year. Excluding one-time gains from asset sales and home office lease expenses in 2018, that would represent an 8% dip from its adjusted EBITDA in 2018.

J.C. Penney didn't provide any longer-term guidance, but analysts expect its revenue to dip another 3% as its non-GAAP earnings improve 34%. By comparison, its ailing rival Macy's (M -1.52%) is expected to post flat sales growth with a 33% earnings drop next year.

The rough road ahead ...

Like Macy's, J.C. Penney is experimenting with new store designs, including a new concept store for LVMH's Sephora, new salon services, fitness classes, lounges, and bistros.

Macy's and J.C. Penney also recently partnered with ThredUP, an online marketplace for secondhand clothing, to bring some of its products to their brick-and-mortar stores. However, it's unclear if any of these efforts will get these aging department stores back on the right track in time for the busy holiday season.

J.C. Penney is making some of the right moves on the bottom line, but it won't be a turnaround play until it generates meaningful comps growth again. Until that happens, investors should simply stick with Amazon, Walmart, and Target, which are all doing their best to render J.C. Penney obsolete.