Filed Under: ,
Tickers in this Article: JCP, M, TGT, WSM, ZLC, SHLD, RL
J.C. Penney's (NYSE:JCP) dismal third quarter results marked the fifth straight quarter in which the retailer has survived an environment that has become increasingly unkind to the U.S. consumer. Although the health of J.C. Penney's bottom line is not likely to improve any time soon, a number of positives for the quarter indicates that J.C. Penney could avoid the retail trash bin, unlike many of its weaker-positioned rivals.

Woe, Is Q3
J.C. Penney's results confirmed that the company has little control over its top line, much like most apparel retailers these days. Plummeting consumer foot traffic caused third quarter sales to fall 8.7% and same-store sales to drop 10.1%. J.C. Penney opened 12 new stores during the quarter, but any contributions from the new stores were greatly diminished because of the overall decline in sales. Management cited continued weakness in the home and fine jewelry departments, which does not bode well for J.C. Penney's pure-play peers such as Williams-Sonoma (NYSE:WSM) and Zale (NYSE:ZLC) in the upcoming and all-important holiday shopping season. (Learn the basics of evaluating store owners at Analyzing Retail Stocks.)

During the earnings conference call, Penney's boasted that it has continued a "leadership position in apparel, where our sales trends have been stronger than our competitors." Unfortunately, J.C. Penney's ability to surpass the likes of Macy's (NYSE:M) and Sears (Nasdaq:SHLD) in sales trends did not manifest into a propensity for profits. The company's dramatically lower sales volume resulted in a 160-basis point increase year-over-year in operating expenses as a percent of sales, leaving operating income down 38%, to $255 million. In addition, higher interest expense helped send total earnings down 53% to $124 million, or 55 cents per share.

Protective Measures
J.C. Penney is doing all it can to batten down the hatches until the worst consumer environment in recent memory subsides. The company plans to control inventory, manage overall expenses and keep a close eye on capital expenditures. Despite these efforts, J.C. Penney still expects negative free cash flow of $250 million to $300 million for the year, which calls into question the sustainability of its dividend. At a current dividend yield of 4.9%, J.C. Penney's dividend is expected to result in an overall payment of less than $200 million from financing cash flow, which is not a good sign for income-oriented investors. However, whether or not the dividend is sustained, curtailed or eliminated altogether clearly depends upon the length and depth of the current recession. (Learn the signs of an impending dividend cut in Is Your Dividend at Risk?)

Last Retailer Standing
Despite near-term doom, J.C. Penney should be able to weather the economic storm. Its 400 off-mall locations - where consumers increasingly have been shopping for years - account for nearly 40% of all stores. The off-mall shopping experience comes at the expense of the traditional shopping mall, but J.C. Penney CEO Myron Ullman believes the strategy will help the company remain well-positioned as it continues to offer consumers a department store experience - but at discount store prices. Additionally, the demise of peers such as Mervyn's and Linens 'N Things has helped rationalize the oversupply of retailers, which works to the advantage of those left standing, including J.C. Penney, Target (NYSE:TGT) and Sears (Nasdaq:SHLD).

In addition, J.C. Penney remains focused on stocking fresh merchandise and currently offers apparel from American Living in partnership with Polo Ralph Lauren (NYSE:RL) and cosmetics from Sephora via a store-in-store format that brings the popular cosmetics concept to 91 of its stores.

Bottom Line
Financial times are mostly tough all over the retail sector and conditions could worsen before they improve. But J.C. Penney is as leveraged as any company in an industry that sinks or swims on the discretionary income of consumers. Therefore, an increase in consumer confidence will result in a return to profitability for J.C. Penney.

comments powered by Disqus

Trading Center