Last Friday, J.C. Penney (JCPN.Q) released its highly anticipated third-quarter earnings report. Its results were very similar to what it reported three months earlier. Comparable store sales fell dramatically, but the company managed to overcome that headwind to improve its profitability significantly.
J.C. Penney stock spiked on Friday after the earnings report was released, but it subsequently surrendered its gains on Monday. For 2019 as a whole, the stock has gyrated wildly, but it currently sits just above the $1 mark, little changed from the beginning of the year.
J.C. Penney year-to-date stock performance data by YCharts.
Investors are having trouble weighing the positives and negatives in J.C. Penney's earnings report. However, while its sharp sales decline was disappointing, the department store operator more than made up for it with an impressive improvement in gross margin.
Sales plunge again
J.C. Penney reported an ugly 9% comp sales decline for the second quarter, as the company exited unprofitable lines of business. On the flip side, gross margin increased by more than 3 percentage points, from 33.7% to 36.8%. Income from J.C. Penney's credit card program surged 64% to $110 million as well, allowing the company to slash its adjusted net loss by more than 50%, to $0.18 per share.
In my Q3 earnings preview, I noted that J.C. Penney faced much easier year-over-year sales comparisons last quarter. As a result, I wrote that sales trends ought to improve significantly -- and that a comp sales decline of more than 5% would be bad news.
Unfortunately, J.C. Penney's sales trends didn't improve at all last quarter. Comp sales plunged 9.3%. Excluding the impact of exiting the appliance business and removing the furniture sections in all of its stores outside Puerto Rico, comp sales fell 6.6%. Management noted that pulling back on promotions definitely contributed to the sales decline. J.C. Penney also reduced its advertising spending last quarter, which presumably weighed on sales. Still, the rapid pace of sales erosion is definitely troubling.
J.C. Penney's recent sales declines have been driven partly by deliberate strategic choices. Image source: J.C. Penney.
Yet profitability improved dramatically -- again
On the bright side, J.C. Penney continued to improve its margin profile last quarter. Gross margin jumped 3.5 percentage points from the prior-year period, reaching 35.4%. The company also posted another big increase in credit income, which rose 45% to $116 million last quarter. Meanwhile, J.C. Penney reduced its selling, general, and administrative costs by 3.3%, to $854 million.
The net result was that adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) more than doubled from $46 million to $106 million. J.C. Penney also slashed its adjusted loss to $0.30 per share, down from $0.52 per share in the prior-year period. Furthermore, J.C. Penney's Q3 2018 results included a $26 million lease buyout payment, making the year-over-year earnings improvement particularly impressive.
Thanks to the jump in its profitability last quarter, J.C. Penney raised its full-year earnings forecast. The retailer now expects adjusted EBITDA to surpass $475 million, compared with its prior guidance range of $440 million to $475 million. This forecast still seems extremely conservative, as adjusted EBITDA totaled $568 million last year and has increased by $38 million on a year-to-date basis.
Modestly good news, on balance
I own a small speculative position in J.C. Penney stock, and as a shareholder, I am concerned about the company's continued sales erosion. Furthermore, the company posted an adjusted net loss of nearly $300 million last year. Even if profitability improves slightly in 2019 -- which would require dramatically exceeding J.C. Penney's guidance -- that would still leave the retailer far from the breakeven mark.
That said, over the past two quarters, J.C. Penney has shown a remarkable ability to grow its earnings in the face of falling sales, just by managing its inventory better and operating more efficiently. Eventually, it will need to get sales growing again, but it's not a big deal if that doesn't happen until 2020. Ending the company's reliance on unprofitable promotions to drive sales is more important.
J.C. Penney's full-year guidance for a 7% to 8% comp sales decline implies that comp sales will fall about 5% to 8% year over year in the fourth quarter. At the midpoint, that would represent a meaningful sequential improvement. And the iconic department store will face easy comparisons throughout 2020 -- plus it should start to reap the benefits of its revamped merchandising and marketing strategies.
Obviously, J.C. Penney is far from being out of the woods. Still, it has made a ton of progress in Jill Soltau's first year as CEO. Despite the substantial challenges it faces, investors shouldn't count J.C. Penney out.
