5 Reasons J.C. Penney Inc. Stock Could Rise

By Markets Fool.com

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J.C. Penney is holding ribbon-cutting ceremonies, but investors might want to stage a ticker-tape parade if the department store chain fulfills its promise. Photo: J.C. Penney.

Wall Street didn't like J.C. Penney's third-quarter surprise. The unexpected revenue shortfall seemed to catch analysts unawares despite the retailer's previous warnings that sales were slowing.

Shares of the department store chain have traded relatively flat since the announcement, and there's concern the weak Black Friday sales numbers may hurt J.C. Penney more than others. But here are seven reasons why the retailer's stock could rise.

1. Sephora generates traffic
The makeup and beauty supplies outlet has been a beneficial partnership since it began. Now outgoing CEO Mike Ullman says Sephora "continues to deliver double-digit growth, drive traffic and generate significant customer loyalty."

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The allure of the cosmetics counter has been a strength of J.C. Penney's turnaround. Photo: Sephora.

Currently in approximately 500 J.C. Penney stores, Sephora accounts for much higher store sales than when it initially began the test run in 2006. The department store thought it would amount to about 5% of sales, but says it's now running in the high single digits. It's even higher at J.C. Penney's smaller stores.

More importantly, the customer that comes in for Sephora buys items in other departments too. She's the second most cross-shopped customer in the store. It's a partnership that will continue paying dividends to J.C. Penney. Traffic overall may still be negative, but it continues to improve sequentially and turning positive is now in sight.

2. Preserving margins through lower clearance
The story at J.C. Penney last year was how it was able to attract customers to its stores once again. A customer once lost is hard to regain. But the department store chain recorded large gains in customers last year, primarily on returning to its roots of the doorbuster sale.

While important to reconnecting with its customers, clearing out merchandise at cut-rate prices is not sustainable for a financially fragile business. This year J.C. Penney believes its inventory is right-sized so that clearance merchandise is down 30% from the year-ago period. It might not generate the same customer traffic as a result, but it's a better customer that's visiting.

And a more profitable one. Although J.C. Penney is still producing losses, they've narrowed significantly and gross margins surged 710 basis points to 36.6% from last year. The retailer expects there to be a 500- to 600-basis-point improvement for the full year as a result.

3. Customers continue to return
Considering Macy's , Kohl's , and Dillard's all reported comparable store sales that were lower than a year ago, the flat comp numbers J.C. Penney recorded is an achievement.

While a component of comps are the prices a company charges -- and Penney's determination to hold the line on giving away the store likely played a role in its better-than-the-competition numbers -- returning customers are also key. The steadily improving customer traffic, combined with fewer promotions than its rivals, allowed J.C. Penney to report better same store sales. These key factors will take on greater significance down the road when J.C. Penney's traffic turns positive.

The weather outside's been frightful, but that should help make holiday sales delightful. Photo: J.C. Penney

4. Seasonal sales
Last year retailers everywhere bemoaned the seemingly strange effect winter weather had on results. Whether it was clothing stores, department stores, restaurants, or even dairies, the harsh snowy weather was blamed for a multitude of under-performance. Even the White House blamed the "snow in winter" phenomenon on the economy's sub-par first quarter.

But this fall, it was warmer weather that burned retailers. J.C. Penney, Macy's, and Kohl's all said the failure of cool, crisp autumn weather to show up on schedule caused customers to stay away later in the third quarter.

Well, we've got our cold weather now (just ask the folks in Buffalo, N.Y.), and that ought to drive sales of seasonal apparel. Expect J.C. Penney to record much higher sales as a result.

5. Profitable where it counts
As noted previously, J.C. Penney's bottom line still sports red ink, but it maintains that it will be free cash flow positive by the end of the year. It's the excess cash that a company generates after paying for investments in its business that drives its ability to return value to shareholders.

Having a firm foundation to build upon, as becoming free cash flow positive would do for J.C. Penney, means it will become more flexible in its options going forward and solidify its fragile financial state.

Let it snow
There's little doubt that reduced consumer spending this Christmas would hit J.C. Penney and all retailers hard. While the five-day Black Friday event the industry ran from Thanksgiving until Cyber Monday was disappointing in many respects, it's also true retailers have expanded the definition of when the Christmas season starts so fighting the crowds during that period is less of an imperative.

Risks remain to J.C. Penney's full recovery, but there's a lot to be hopeful for too. The factors above could play a role in sending the department store chain's stock higher.

The article 5 Reasons J.C. Penney Inc. Stock Could Rise originally appeared on Fool.com.

Rich Duprey owns shares of J.C. Penney Company. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple and Dillard's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.