Discount-retailer stocks have historically been relatively safe ways to play the U.S. consumer space, as the names often offer value share prices, generous yields or both. That tends to make this group attractive to investors, particularly when valuations move down during weak periods. Let's check out one such name -- struggling J.C. Penney (JCP) , which recently hit an all-time low.
J.C. Penney was founded in 1902 by James Cash Penney in Kemmerer, Wyo. The first store was called The Golden Rule, and in the 116 years since then, the chain has expanded to almost 900 locations, 100,000 employees, $12 billion in annual revenue and a $550 million market capitalization.
But the company has made headlines in recent years for all of the wrong reasons. JCP has struggled mightily to keep pace with a retail environment that's rapidly evolving to an online experience, with earnings -- and share price -- suffering as a result. The chain has also been hurt by an unfavorable merchandise assortment.
Weak Earnings and a Record-Low Share Price
J.C. Penney's recently released fiscal-second-quarter earnings were weak enough to send the stock to $1.60, an all-time intraday low. The chain reported a 38-cent-per share net loss, deeper than the 7-cent per-share loss recorded in the same period last year.
Total sales likewise fell 7.5% from the same quarter last year, although that partly stemmed from closure of 141 stores that JCP shuttered in a bid to reinvigorate results. Excluding those shops, comparable-store sales actually rose 0.3%, a 160-basis-point improvement over last year's second quarter.
JCP reported strength in women's apparel, where sales grew for the first time since 2015's fourth quarter. In addition, the company's Arizona brand drove positive results in men's, women's and children's apparel.
Penney's also opened 650 Fanatics shops inside J.C. Penney stores in an attempt to attract additional traffic. Adding this popular online sports-apparel retailer to struggling stores should help bring in some customers.
Still, JCP reported that its gross margins fell 160 basis points during the second quarter to reach 33.7%. Management attributed the drop to markdowns used to clear slow-moving inventory on seasonal items.
That's a significant headwind given J.C. Penney's struggle with profitability, but management is taking actions to improve things. While the company traditionally purchased inventory to fill its entire stores, it's now focusing on favorable trends, plus categories that show demand -- meaning JCP will be buying less merchandise moving forward.
Indeed, management said that while second-quarter inventory receipts ran ahead of sales because of prior purchase agreements, that situation should abate over time. We should see margins improve as the company buys less merchandise, as that means that JCP should need fewer markdowns to clear old inventory. This will be a relatively slow process, but the pieces are in place for the chain to see improvements in net pricing over time.
Penney's also reported that its "SG&A" expenses (selling, general and administration) fell on an actual-dollar basis, although they rose as a percentage of revenue because sales fell so sharply from last year's levels. This 60-basis-point deleveraging negatively impacted operating margins.
Former CEO Marvin Ellison rather abruptly resigned during the second quarter, so the remaining management team is running the company while searching for a permanent replacement. Management guided for flat comparable sales for 2018 as a whole, as well as for an 80 cent to $1 loss per share.
Plenty of Risk
I see rather pedestrian returns for shareholders moving forward, with the picture muddied by the immense risks that surround the business. For instance, JCP's free cash flow totaled a minus $235 million during 2018's first half, although that's an improvement over last year.
In addition, the company has $2.2 billion in available liquidity and $2.8 billion in inventory vs. $2 billion in current liabilities. So, I don't see bankruptcy as an imminent threat given that results are improving and that Penney's has significant untapped liquidity. However, I recognize the risks given that the company is still operating at a meaningful loss.
The Bottom Line
J.C. Penney's valuation has obviously declined significantly, as investors have largely given up on the chain. In fact, you can't really value the stock based on earnings because those have been negative for some time.
As an alternate valuation measure, I'd note that JCP is trading at about a 0.49 on a price-to-book basis -- its lowest such value in recent memory. I anticipate a reflation to 0.65x book value over time assuming that turnaround efforts bear fruit, but the stock still presents significant risks to shareholders.
Investors clearly haven't bought into the idea that J.C. Penney is going to turn around, and I don't expect the company to resume paying a dividend for a very long time (if ever). Thus, I see relatively modest total percentage returns in the mid-single digits, consisting of:
- Book-Value-Per-Share Growth: Low single digits.
- Dividend Yield:
- Valuation Expansion: Low- to mid-single digits.
All in all, J.C. Penney offers investors an interesting turnaround story with a lot of potential, but there's also a meaningful risk that the stock eventually goes to zero.