After yet another quarter of improving results, J.C. Penney (OTC:JCPN.Q) looks like it's finally back on the road to good health. Losses narrowed, sales grew, and more importantly comparable sales are up yet again, meaning customers are liking what they see and are returning. It's anticipating a strong back-to-school season and is ready for the Christmas holiday with sufficient financing to help it appropriately manage inventory levels.
The better performance in the most recent quarter led to a near-10% jump in the shares of the department store operator in the days following the earnings release, and they've more than doubled in value from the low point they hit back in February as it seems the turnaround plan being implemented has taken root.
Of course Penney is still a work in progress and it has a long way to go before it gets back to the levels it achieved in 2011 before the wheels came off, which is why it's useful to look at what could go wrong before it crosses that finish line.
Home hasn't been where the heart is
If there's one piece that's been weakest longest it's Penney's home store, which experienced some of the biggest declines in sales of any of its departments over the past two years.
Although it has made a lot of changes and over the first six months of 2014 the situation has substantially improved -- particularly sequentially, where in-store sales jumped 25% in the second quarter -- the department remains a weak brick in Penney's foundation.
It's still overly represented in the store's clearance items, and though Penney made a lot of progress there as well, home goods clearance still served as a drag on sales. If it can't work through that backlog of goods or the division turns down again, it will play a significant part in setting Penney back.
Clearing the decks
Speaking of clearance items, as mentioned, the department store has done an admirable job of clearing out the clearance goods, and that was a large reason why it enjoyed such nice improvements in its margin, but clearance items still remain well above historical norms and it needs to get back to those levels and stay there before it can hope to see sustainable high profit margins.
Fashion is fickle, and right now Penney seems to be hitting on all cylinders when it comes to apparel, particularly women's, but it wouldn't take much -- missing a trend, wrong styles or color -- and we could see a lot more goods being tossed onto the bargain sale racks.
For example, other than its Disney (NYSE:DIS) line of goods, Penney's kids department has been exceptionally weak. The team it had in there did a poor job of sourcing the goods and missed some important opportunities when it came to private label clothes. They've now brought new people in and are anticipating things to turn around, but management says it won't be seen (or felt) until the fourth quarter. That means any missteps there won't raise their head till later on, too, and could come as a nasty shock to investors.
Where's a traffic cop when you need one?
Improvements in any of these areas -- home, kids, clearance -- can lead to increased traffic numbers, which remain low. Like much else in the J.C. Penney story, things are better than they were, and the second quarter was much better than the first, but store traffic is still negative and it is entering a period where it's comparables on the metric may be tough to duplicate.
Although both Macy's (NYSE:M) and Kohl's (NYSE:KSS) also experienced negative traffic numbers, meaning it's partly out of Penney's hands, the retailer last year was able to drive customers to its stores with the return of it's blowout sales, such as its "Biggest Sale of Them All" promotion last November.
Since ex-CEO Ron Johnson had eliminated sales in favor of everyday low pricing, the resurrection of the doorbuster event was something of, well, an "event." It's not going to have that same luxury now where the customer is once again acclimated to Penney running regular sales.
But if it can't start generating positive store traffic numbers, the renaissance it's enjoyed will crumble. Bringing more people into the store is how retailers grow, but earlier this year the Wall Street Journal noted there's been "a long-term change in shopper habits (that) has reduced store traffic -- perhaps permanently -- and shifted pricing power away from malls and big-box retailers."
How Penney resolves this remains dependent upon a combination of initiatives it takes, such as trying to convert more online sales into pickup in store sales. Yet it's still going up against high unemployment, higher costs, a sickly economy, and a challenged customer such that the retailer will be hard-pressed to succeed.
Foolish investment takeaway
When you look at these three items you realize just how far J.C. Penney has come from only a year or so ago when everyone was chipping in to the office death pool on predictions for when the demise would come.
The fact that it didn't go under and indeed has even thrived a bit in its turnaround effort shows it's closer to health than death these days. But that doesn't mean it can't or won't change in a hurry once again. The speed at which Penney fell from grace was breathtaking and the road to recovery is much longer.
Things are looking up for J.C. Penney investors these days, but that doesn't mean they shouldn't still be looking over their shoulders.