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J.C. Penney Results Encouraging as New Strategy Implemented

Written by on May 24, 2013

J.C. Penney announced first-quarter 2013 earnings after the market close Thursday, having released a press release a week ago disclosing a 16% sales decline in the quarter. While adjusted loss of $1.31 per share was worse than the mean analyst expectations given former CEO Ron Johnson’s sudden departure at the beginning of April and the announced $850 million draw on the company’s line of credit, visibility was low and expectations of bad news were high.

Discussions during the conference call of the competitive environment and the consumer’s widened range of retailer choices underline our no-moat rating for Penney, yet comments from the call give some confidence that the returning pre-Johnson CEO Mike Ullman can find the right combination of promotions, new products, and private label.

Looking at the balance sheet, after the $850 million revolver draw, cash was only $19 million lower than the fourth quarter. Inventories were down over first-quarter 2012 by $286 million, or 9%, but still represented a use of cash for $457 million compared with $168 million use in the same period last year. Offsetting the inventory use of cash, payables were a cash source of $85 million, and management believes work it has done over the past year should lead to permanently better terms from vendors.

Deferred taxes were also a significant use of cash at $168 million, but should likely be a cushion later as assets can be used to offset tax liabilities. Capital expenditures were $214 million in the quarter, and the company explained that as part of soon-to-be-completed remodeling work, especially in the Home department, an additional $335 million of capital expenditures were accrued but unpaid as of the end of the first quarter, which will further affect cash. For the rest of the year, management plans on minimizing capital spending (perhaps to just $60 million) to conserve cash until profitability returns.

Much of the discussion on the conference call was around what it will take to get customers back and the time and effort needed to affect merchandise and ticket pricing. Management expressed that it does not see any structural reasons the business cannot recover. CEO Ullman also stated that his consumer research suggests that cutting several of the top private-label brands out of the merchandise assortment was a significant mistake, and that given the return to the promotional pricing strategy, those brands will be brought back.

The goal is now for the company to be back in business in those brands and substantially reticketed and repriced by fall, giving some additional breathing room before the holiday period. Although management was limited in what it could say about current conditions and responses to advertising and promotions, owing to the in-progress closing of a new loan and concurrent bond tender offer, analysts did take management’s comments as confidence that traffic and conversion will improve with the return to a more promotional business cadence.

Ullman also mentioned that he has personally met with top vendors of national brands, and believes he can preserve the progress on what he is calling “featured business” (in lieu of “shops”), such as Joe Fresh. Ironically, during the first quarter and prior year, the one business area that experienced a sales increase was Sephora (a division of LVMH MC), which is a full-price business and attracts younger and more affluent customers.

Yet at the same time, the private brand St. John’s Bay, which was over $1 billion in sales, was called out in numerous mentions of customer research as being greatly missed. It appears that the way forward is a combination of new features and well timed promotions, which if successful should leverage profits given the current low expense structure.


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