Why Wall Street's Doubts About J.C. Penney Are a Buying Opportunity

Retailer took a drubbing in the market after earnings beat the Street, which is good news for investors.

Rich Duprey
Rich Duprey
Nov 13, 2015 at 5:15PM
Consumer Goods

Maybe it's because J.C. Penney keeps beating analyst estimates that Wall Street is beating up on the retailer. 

You can sum up the Wall Street's view of J.C. Penney (NYSE:JCP) as "What have you done for me lately?" Or maybe it's "What have you done right this minute?"

The department-store operator pretty much demolished analyst expectations. It reported a nearly 5% increase in third-quarter revenues, or $2.9 billion, which was better than the $2.88 billion analysts forecast; a loss of just $0.47 per share, narrower than consensus estimates of $0.56; and same-store sales that jumped well over 6%, topping out ahead of the 5.6% expected -- but J.C. Penney's stock is tanking.

Perhaps it's more a matter of letting no good deed go unpunished.

Under the microscope
The view is that J.C. Penney didn't raise its full year sales guidance, so despite doing well so far, it's fourth quarter will be weak because it's leaving in place its forecast that comps will rise between 4% and 5% for the year.

Following Macy's (NYSE:M) own poor performance the other day that also hit J.C. Penney's stock when it preannounced its third-quarter comps and said it had settled a niggling fake-prices lawsuit that's snared a few other retailers, it seems investors remain concerned the economy isn't as healthy as we've been led to believe.

Yet Kohl's (NYSE:KSS) reported its third-quarter earnings on Thursday that were at best on par with J.C. Penney's results and in many instances comparatively worse, yet its stock jumped 6% on the day. Its revenues, adjusted earnings, and comps were all all just 1% higher in the period, respectively.

The dichotomy suggests the market is still not sure that J.C. Penney has really turned the corner on its financial woes, and that means investors have a buying opportunity.

Always the underdog
At every stage of the turnaround, Wall Street has underestimated the strength of the retailer's recovery, and almost every quarter we hear stories about how it "surprised" analysts yet again. Even so, they remain dour on their outlook. Good. It puts J.C. Penney's stock on sale, giving investors a better buy-in price.

Looking at the department store's performance, we see it enjoyed good results across the board, with every merchandise division reporting higher comps. Same-store sales are an important retail metric, because it strips away growth that's achieved simply by opening more stores. It's a more organic measure of improvement.

J.C. Penney continues to reap benefits from its partnership with beauty and personal-care specialist Sephora. Photo: Sephora.

As we've come to expect, J.C. Penney's partnership with beauty-care consultant Sephora continues to pay dividends, but the extra effort it's also put into the home-goods business is also paying off and was called out along with men's, footwear, and handbags. These have all been divisions J.C. Penney has said in the past it needs to turn up if it's going to be able to reach its goal of generating $1.2 billion in EBITDA by 2017. That they are responding is good news.

A lump of coal for Christmas?
But what of the worry that it's actually telegraphing a weak fourth quarter? Certainly the inventory buildup that Macy's reported should give pause that department stores still face headwinds, and the mild weather we've been blessed with could wreak havoc with retailers rolling out their winter lines.

We heard that excuse last year from retailers, including J.C. Penney, so it's not an uncommon occurrence and shouldn't come as a surprise if it manifests itself again. Yet the year before we had stores blaming the seemingly strange "snow-in-winter" phenomenon for keeping people away, so investors should understand these events tend to work themselves out eventually over time.

J.C. Penney continues to drive its costs down, reducing SG&A costs by $47 million in the third quarter, while its gross margins improved 70 basis points to 37.3% of sales. It cleared out its clearance racks last year, generating a 710-basis-point improvement in margins, and has found its inventory at appropriate levels since.

In all, the dangers of collapse for J.C. Penney are mostly in the rearview mirror. It's remained steadily on course and is still headed in the right direction. If the markets want to give investors discounts to buy its stock, investors should take them up on it.