Shares of beleaguered department store J.C. Penney (NYSE:JCP) surged when the company announced that comparable store sales during the nine-week holiday period grew by 3.7%. This appears to improve upon the 3.1% growth reported during the 2013 holiday season, and it's significantly better than the massive sales declines of 2012. However, let's explore why investors shouldn't be fooled by this cheery result.
Moving the goalposts
Comparable store sales is one of the most important, if not the most important, metric for retailers. It strips out the effects of store openings and closings, giving investors a look at how the stores are really performing.
However, comparable store sales is not a generally accepted-accounting-principles figure. This means that companies are free to calculate it in whatever way they choose, and they can make changes to the calculation at any time, as long as they disclose it in their financial reports. This is exactly what J.C. Penney did during the first quarter of 2014.
This is what J.C. Penney stated in its Q1 10-Q:
Comparable store sales increased 7.4% for the first quarter of 2014. During the first quarter of 2014, we simplified our comparable store sales calculation to better reflect year-over-year comparability. Certain items, such as sales return estimates and liquidation sales, are now excluded from the calculation. Under the old methodology, comparable store sales in the first quarter increased 6.2%.
During the first quarter, J.C. Penney reported rather robust 7.4% comparable store sales growth. But a change in the way comparable store sales were calculated accounted for 1.2 percentage points of this growth. This was the only quarter in which J.C. Penney disclosed the difference between the two calculations, so in all future quarters the number generated by the new method was the only one reported.
There's really only one reason why a company changes the way they calculate something: to make it look better. Again, comparable store sales is non-GAAP, so there's nothing wrong with what J.C. Penney did. But since this change hasn't been lapped yet, the 3.7% holiday sales growth from 2014 isn't directly comparable to the 3.1% holiday sales growth from 2013.
It's possible that holiday sales actually grew more slowly in 2014 compared to 2013, once adjusted for the difference in calculations. All we can safely say is that they were in the same ballpark. The results from the full fourth quarter, which will be presented in February, also won't be directly comparable to the fourth quarter of 2013. If there's any improvement over the 2% comparable store sales growth during the fourth quarter of 2013, a significant portion of it will likely be due to the change in calculation method.
J.C. Penney has managed to successfully complete step one of its turnaround effort. The company stopped the bleeding and returned to sales growth, stabilizing the business. The problem is that sales are so far below where they were in 2010 that low single-digit comparable store sales growth just isn't very impressive.
Competitor Macy's reported holiday comparable-store sales of 2.7%. J.C. Penney appears to have done slightly better, but the calculation method change muddles the picture. What we can say is that J.C. Penney and Macy's had roughly similar results, and that's a big problem. J.C. Penney lost around one-third of its sales during the Ron Johnson era. In order to claw its way back, it needs to be winning market share. But if it's growing at roughly the same rate as its competitors, that's clearly not happening.
J.C. Penney is closing some underperforming stores, and that's certainly a positive development. The company announced that it would be closing 40 of its over 1,000 stores this year, and that should help cut costs. But J.C Penney's problems won't be solved by closing a small number of stores. During the third quarter of 2010, J.C Penney recorded revenue-per-square-foot of about $37.40. In the third quarter of 2014, this number fell to $25.60. Total gross selling space has only decreased by about 3.5% during this time, despite the massive collapse in sales.
J.C. Penney's main problem is simple: It's not selling enough stuff. The company is growing revenue from such a depressed base that it should be blowing its competitors out of the water when it comes to comparable-store sales growth. The fact that it's not is troubling. If J.C. Penney grows revenue at a 4% annual rate going forward, it would take nearly 10 years before the company gets back to 2010 levels. And that assumes nothing goes wrong for the next decade.
J.C. Penney's holiday sales just weren't very good, despite the stock market's reaction. Right now, its sales relative to its retail footprint puts the company in an unsustainable situation, and it needs to grow sales much faster to have any chance of returning to profitability in the foreseeable future. After the first three quarters of 2014, J.C Penney's net loss stood at around $700 million. Costs can only be cut so much, and at some point J.C. Penney needs to show that it can get people back into its stores and win market share from competitors. So far, none of this has happened.