Normally when a struggling retailer such as J.C. Penney (NYSE:JCP) announces a same-store sales increase, it's a reason for celebration. While a sales increase normally offers a positive sign of a turnaround, sometimes it may actually provide a false positive for an otherwise failing business. A closer look at J.C. Penney's October sales report reveals more, not less, trouble ahead amid mounting price competition from the likes of Macy's (NYSE:M) and Dillard's (NYSE:DDS).
On Nov. 7, J.C. Penney provided a progress report of its turnaround based on October results. In the report, it stated that same-store sales increased 0.9% and online sales increased 37.6%. CEO Mike Ullman called this "significant progress," and he stated, "We believe the Company is on the right track to return to long-term profitable growth." On the face of it, that's not too shabby.
J.C. Penney listed a couple of macro challenges it overcame; the federal government shutdown and the challenging consumer economy. J.C. Penney was proud that, despite those issues, it had its biggest same-store sales increase since December 2011. The company credited the tiny rise with its restoration of inventory in certain key brands along with "remerchandising and reconfiguration of its Home department both in stores and online."
While a 0.9% increase doesn't sound like much especially if you account for inflation, J.C. Penney needs to start somewhere. However, buried further down in the same press release, it revealed the more probable reason for the rise. It stated:
"Overall, gross margin for the third quarter was negatively affected by lower clearance margins due to the overhang of inventory from the first two quarters of the year, higher levels of clearance units sold, as well as the Company`s transition back to a promotional pricing strategy."
This sounds almost like a garage sale. J.C. Penney had an overhang of inventory from two previous quarters and it slashed prices to get rid of this inventory. Over the last two quarters, unsold inventory grew by 35%. This all means that with J.C. Penney slashing prices on old and even new inventory, it stimulated overall sales a tiny bit while seeing less profit from those sales.
Normally a company confirms a turnaround by growing profit rather than by growing sales a tiny bit at the expense of profit. The problem, besides the lowered profit, is that inventory clearance sales can't last forever.
J.C. Penney also reported that actual guest traffic was down, not up. This provides further evidence that the main reason it saw a slight increase in sales in October was simply the individual consumer purchasing more of the garage-sale-like discounted old inventory. Not surprising, average units sold per customer went up. Consumers love bargains. Companies rarely celebrate a decrease in guest traffic and call it a turnaround.
Dillard's, likewise, reported positive same-store sales. Its sales were up 1%, also higher than J.C. Penney for the quarter. While that's not much of an increase, its gross margin stayed very steady. Dillard's saw a 36.8% gross profit margin which compares to 37.1%.
Foolish final thoughts
Clearly J.C. Penney's competitors are able to grow sales at a faster clip without using piles of discounted old inventory to do it. Keep an eye on J.C. Penney's gross profit, instead of just sales, as this may tell you if a real turnaround is going on. Until that happens, as a prudent investor, be skeptical of headlines that do not necessarily tell the whole story.