J.C. Penney Co. Inc. is out of step with the rest of the retail sector.
As rivals stage a steady rebound from the weakness of the last few years, the Plano, Texas–based department-store chain JCP, +2.81% has deteriorating financials, is struggling to identify its core customer and is still searching for a new chief executive, all issues that analysts say could push it into bankruptcy if it can’t turn things around quickly.
Penney’s second-quarter earnings report last week delivered the latest in a string of disappointing numbers, sending shares down almost 27% in their biggest one-day tumble in J.C. Penney’s 40-year history as a public company. The day ended with the stock at its lowest level on record. The stock, in fact, has fallen more than 51% in the past year, vastly underperforming the SPDR S&P Retail exchange-traded fund XRT, -1.10% , which has gained 34%, and the S&P 500 SPX, +0.62% , which has gained 17%.
The results and lowered guidance prompted S&P Global Ratings to downgrade the company’s credit rating to B- from B, sending it deeper into speculative-grade, or “junk,” territory. The downgrade reflects “continued weak operating results, compounded by persistently ineffective inventory management that has been a primary contributor to margin pressure and, in our view, indicates increasing execution risk,” said S&P.
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StockTwits co-founder Howard Lindzon and MarketWisdom.com co-founder Ivaylo Ivanov this week compared J.C. Penney to another troubled retailer that many are expecting to collapse. The two investors said the “retail sector is the clear leader right now,” with lots of earnings beats and upbeat guidance — but not everyone is benefiting.
“Retail really is dead if you’re J.C. Penney, if you’re Sears,” Lindzon said.
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The comparison seems apt, looking at Penney’s stock price, which is hovering around $1.80, not too far from Sear’s stock price of $1.13. (Its market capitalization of some $570 million as of Friday afternoon, however, is nearly five times Sears’s.)
‘[T]he company has changed direction several times — first trying to attract younger shoppers, then younger moms, and now back to older shoppers. In our view, this flailing around is a symptom of a wider problem in that J.C. Penney no longer has a sense of what it wants to be and who it wants to serve.’ Neil Saunders, GlobalData RetailJ.C. Penney has failed to zero in on its customer base over the past few years, Chief Financial Officer Jeffrey Davis conceded on the company’s recent earnings call, and the business is hurting because of it.
In its most recent quarter, the company had to discount slow-moving and excess seasonal inventory to prepare for the back-to-school season. J.C. Penney expects to reduce its enterprise inventory by at least $250 million by the end of fiscal 2019.
Davis said the company “believes” that its core customer is a woman aged 44 to 55-plus and said it is “shifting our philosophy from buying to store capacity to buying and chasing into demonstrated sales trends,” according to a FactSet transcript.
But Neil Saunders, managing director of GlobalData Retail, said J.C. Penney has simply lost its way.
“[T]he company has changed direction several times — first trying to attract younger shoppers, then younger moms, and now back to older shoppers,” he wrote. “In our view, this flailing around is a symptom of a wider problem in that J.C. Penney no longer has a sense of what it wants to be and who it wants to serve.”
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By the numbersThat lack of focus is compounded by J.C. Penney’s deteriorating financial situation and efforts to reduce a long-term debt load that stood at more than $4 billion in May, when the company filed its annual 10-K with the Securities and Exchange Commission.
Research firm CreditSights is expecting the company’s fiscal 2018 earnings before interest, taxes, depreciation and amortization (EBITDA) to come to $645 million, which would no longer be free-cash-flow positive, assuming full-year capital expenditures of $400 million and interest costs of about $300 million.
“This, of course, reduces the organic opportunities for debt reduction — which was one of the actions we appreciated previously in the J.C. Penney story,” CreditSights analysts James Goldstein and Jesse Wasily wrote in a post-earnings commentary.
J.C. Penney has taken action to raise cash. It sold a fleet of corporate jets, a Connecticut distribution center and an interest in a California mall. But its strategy for 2019 is unclear, it still has no CEO, and the interim “office of the CEO” members are scrambling to take the chain back to its perceived customer base. The fast-fashion strategy that CFO Davis introduced may not be the best next step.
“[F]ast fashion seems to have lost momentum in the U.S. market — if H&M is any indication,” the analysts said, as they downgraded the company’s bonds to hold from outperform.
“We’re not convinced the story is over for J.C. Penney given decent liquidity, a lack of aggressive cash burn, and relatively minor near -term maturities (just $50 [million] in 2019), but we think it is appropriate to take some risk off the table and scale our recommendation,” they said.
CreditRiskMonitor, a risk-analysis group, includes J.C. Penney on a list of retail companies at high risk of bankruptcy. “Overall, we remain somber about J.C. Penney,” said Saunders from GlobalData Retail. “The company just feels increasingly tired and lacking in spirit.”
J.C. Penney representatives had not responded to a MarketWatch request for comment.
Tracing past misstepsSome of J.C. Penney’s current challenges can be traced to missteps in the past, not least by Ron Johnson, the Apple Inc. AAPL, +0.31% veteran who joined the company as its top executive in November 2011 and was ousted a year and a half later, having lost $1 billion.
“It’s an unmitigated disaster,” said Hedgeye analyst Brian McGough, when Johnson’s departure was announced.
One of the major changes Johnson made was to eliminate J.C. Penney’s coupons, which were a customer favorite.
“They made some significant bets in terms of how to reposition the business that ultimately proved not to resonate with the consumer,” said Christina Boni, vice president at Moody’s. “The reduction of promotions particularly in the customer’s mind was a difficult adjustment to make.”
Boni said she would like to see J.C. Penney reposition itself in a way that resembles its pre-Johnson setup, but acknowledged that once a customer has walked away, it’s hard to get him or her to return.
“Marvin Ellison made some significant strides getting the company back on track, getting the company some stability, deleveraging it, she said, referring to J.C. Penney’s previous CEO, who has since moved on to the leadership position at the home-improvement retailer Lowe’s Cos. LOW, -0.33% , leaving the vacancy at the top. “That’s clearly reflected in our B2 stable rating versus the previous distressed level.”
Ronald Tysoe, chairman of the J.C. Penney board, said in the company’s recent earnings release that the Penney has met “highly qualified candidates” who are strongly interested in taking the role. Finding a new CEO is the top priority of the board, he said, “and we will continue to expedite the process in order to bring this search to a successful conclusion.”
In the meantime, other retailers are working to keep up with changing consumer habits, making expensive digital upgrades to accommodate multiplatform shopping, investing to create an entertaining and engaging in-store shopping experience, and curating merchandise to reach a target customer who will become a loyal customer.
And they’re showing positive results from their efforts to keep up with the shift to e-commerce.
Target shares TGT, +0.69% are up 4.4% this week after the company reported upbeat earnings and raised its guidance. Walmart Inc. shares WMT, -0.24% gained more than 9% after it beat sales, earnings and same-store sales expectations. Nordstrom Inc. JWN, +0.10% was up more than 13% the day after that relatively upmarket department-store retailer beat expectations, showing strength in e-commerce.
And though shares of Macy’s Inc. M, -4.25% were down 16% after the company reported earnings that beat expectations and raised guidance, its shares have rallied more than 77% in the past 12 months.
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“After a period of protracted performance, department stores have been resurfacing with a leaner, more refined focus,” wrote Moody’s in a note. “The goal is to take the friction out of shopping for a growing base of demanding customers spoiled for shopping choices.”
So far, the new strategies are paying off.
“Many are still in transition, but early indications are that the big competitors are making important progress,” Moody’s said.
J.C. Penney is a few steps behind.
“It’s an old, tired department store that hasn’t really reinvented itself,” said Sucharita Kodali, retail analyst at Forrester.
J.C. Penney, founded in April 1902, has more than 860 stores in the U.S. and Puerto Rico, along with an e-commerce site. It closed 141 stores in fiscal 2017.
“It’s a big business, and that means you have to do more to change things,” said Kodali.
J.C. Penney has tried a variety of things, including building out its Sephora shops and expanding in the appliance and baby categories. Kodali said it need needs to close many of its stores and focus on e-commerce.
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“The locations aren’t great,” she said, with many stores in lower-tier malls. “You have this albatross around your neck with all these low-quality locations.”
Therace Risch, J.C. Penney’s chief digital officer, said on the earnings call that the company has pulled back on online sales while it adjusts its assortment.
“The most worrying thing about the results is that if J.C. Penney can’t perk itself up at a time when the retail mood is elevated, it suggests that there are fundamental weaknesses in the company’s position,” said GlobalData’s Saunders.
