Shares of JC Penney (NYSE:JCP) recently rebounded from historic lows after the company's third-quarter numbers unexpectedly beat analyst expectations on the top and bottom lines. Its revenue fell 1.7% annually to $2.81 billion, but still beat estimates by $40 million. Its adjusted loss widened from $0.21 to $0.33 per share, but that still topped expectations by $0.10.
That earnings beat was surprising -- JC Penney had warned that it would post a loss of $0.40 to $0.45 per share just two weeks prior to the report. At the time, the retailer believed that the liquidation of its slower-moving inventory, particularly in women's apparel, would produce a wider loss. It also previously forecast comparable store sales growth of just 0.6% to 0.8%, while comps actually rose 1.7%.
IMAGE SOURCE: JC PENNEY.
Some investors are probably scratching their heads and wondering if it's finally time to buy this beaten-down stock, which has fallen more than 60% for the year. Let's take a fresh look at the bull and bear cases to decide.
The reasons to buy JC Penney
During the conference call, CEO Marvin Ellison stated that JC Penney's liquidation of slower-moving women's apparel helped it "reset" that core business (which generated almost a quarter of its revenue last year) by pivoting away from "traditional" clothing and toward "casual and contemporary offerings."
Ellison claims that move enabled women's apparel to generate positive comps growth in October (its first positive growth in 14 months) even after excluding the short-term benefits from its accelerated clearance sales. He also believes that a heavier emphasis on footwear, via partnerships with Nike and Adidas, could help JC Penney tap into the growing athleisure market for female shoppers.
JC Penney's appliance sales surged 128% year-over-year, indicating that the business remains well insulated from e-commerce challengers. Appliance showrooms that opened last year generated more than 30% comps growth.
JC Penney's online business also continues to grow, with its ship-from-store fulfillment strategy expanding to all of its stores. 30% of all its online orders were shipped from those stores last quarter. Its app downloads also rose 10% annually, and it's relying more heavily on data gathered from that digital ecosystem to make pricing decisions.
The reasons to sell JC Penney
Despite those improvements, JC Penney's full-year forecast remains unchanged from its prior warning. It still expects to post flat to -1% comps growth, with an adjusted EPS between $0.02 to $0.08 -- compared to earnings of $0.08 per share in fiscal 2016. This means that JC Penney isn't out of the woods yet, and that most of the damage from its liquidations could appear in the fourth quarter instead of the third.
Many of JC Penney's bottom line "improvements" also come from non-recurring asset sales and store closures instead of organic growth. JC Penney finished last quarter with just 874 stores, compared to 1,014 stores in the prior-year quarter. Shuttering stores to boost earnings growth isn't a sustainable long-term strategy, as we've seen in the ongoing collapse of Sears Holdings(NASDAQ:SHLD).
IMAGE SOURCE: GETTY IMAGES.
Meanwhile, growing earnings naturally could be tough for the company due to its focus on higher-growth (but lower-margin) appliances and e-commerce. JC Penney also admits that it tested a "series of pricing promotional strategies to drive dotcom traffic in the third quarter" which reduced the digital business' gross margin.
That's troubling, since JC Penney's core turnaround strategy for women's apparel requires it to counter some very tough, low-margin rivals like "fast fashion" leaders Inditex's Zara, H&M, and Forever 21. The footwear and athleisure market also isn't a sure bet these days due to market saturation and a growing number of direct-to-consumer channels.
If both JC Penney's higher-growth and slower-growth businesses fail to lift its earnings and its operating expenses keep rising on its turnaround efforts, it's hard to see how its earnings can improve without additional store closures or asset sales.
The verdict: Avoid JC Penney for now
JC Penney admittedly looks cheap at 0.1 times trailing sales. But it's cheap for a reason -- the market doesn't think it can keep growing its sales and earnings without making some big sacrifices.
Appliance sales, e-commerce growth, and liquidations might lift its revenue at the expense of earnings, while store closures and asset sales could boost its earnings at the expense of revenue growth. That's a tough balancing act to pull off -- especially with e-commerce giants, superstores, and fast fashion apparel rivals all attacking JC Penney from multiple fronts.
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