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Things aren't nearly as bad at J.C. Penney as the market's initial reaction to its earnings report would suggest.
There was only one negative surprise in J.C. Penney's fourth-quarter earnings report: adjusted earnings broke even instead of the $0.11 per share profit Wall Street was expecting.
OK, that's a doozy of a miss, and seemingly vindicates analysts who have otherwise gotten the retailer's recovery wrong all along. But it's also a superficial analysis -- and wrong again about where J.C. Penney is heading.
As retiring CEO Myron Ullman explained to investors during Penney's earnings call, 2014 was a good year for the department store chain. Here's what he said, along with four more things J.C. Penney management wants shareholders to know.
Aside from the losses, 2014 was good to J.C. Penney
Ullman began by highlighting the significant gains the retailer achieved last year: "We significantly grew sales and gross margin, and delivered on our goal to generate positive cash flow. We generated over $50 million in free cash flow, which represents a $2.8 billion improvement over last year."
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The consumer realizes J.C. Penney is back in a big way, and as operations have gotten back on track, the company's financial footing has dramatically improved. It has over $2.1 billion in liquidity, or cash that it can access on short notice as needed; has no short-term borrowings; and debt, though relatively high at more than $5 billion, is manageable.
Ullman went on to note, "We achieved what we set out to do, meeting or exceeding our sales, gross margin, and other financial targets and, most importantly, we positioned the company for continued success in 2015 and beyond."
The retailer is finding its center
The center of J.C. Penney's resurrection has been what it calls its core merchandise categories: the store-in-store beauty supply boutique Sephora, and fine jewelry, both of which typically offer some of the highest margins in the store.
The new exclusive Modern Bride collection of rings and settings at J.C. Penney is proving to be a high-margin profit center. Image: J.C. Penney.
Sephora boutiques are now inside nearly 500 stores, with plans for 25 more locations in 2015. And fine jewelry again turned in a strong performance last year as the retailer added a new aspirational engagement ring collection designed exclusively for J.C. Penney. It also opened the Modern Bride Diamond Vault, where customers can hand-select their diamonds and then choose the setting of platinum, white gold, or yellow gold.
As Ullman stated, "we expect this high-margin business to continue to thrive."
Being everything to everyone
J.C. Penney's online channel is also making substantial improvements, with sales jumping 12.5% in the fourth quarter to $428 million. While that was just 11% of the retailer's total revenue, it also drives efficiency through low overhead. But e-commerce is just one part of the company's omnichannel strategy in which it is trying to touch customers wherever they are.
Ullman made a point to highlight the return of the J.C. Penney catalog: "This year, we're also bringing back more print marketing, including a 120-page catalog dedicated to home merchandise. This catalog will land on coffee tables in March and remain active for four months. "
Margins are getting fatter
Now that the retailer has emptied its shelves of clearance merchandise, its margins have also improved significantly. Gross margin rose by 540 basis points for the year, hitting 34.8% of sales, while adjusted EBITDA (or earnings before interest, taxes, depreciation, and amortization) improved by nearly $900 million year-over-year.
Ullman was justifiably happy with the margin gain because it implied "efficiency improvements, which will yield higher future profits as J.C. Penney is figuring out ways to eliminate waste."
Home is where the sales are
The home department remains a key driver of store traffic andwas one of J.C. Penney's best-performing businesses in 2014, both in-store and online. Ullman knows it won't account for 50% of e-commerce sales as it once did, but said that as the department store reshapes the customer's shopping experience, while improving the utilization of space in the store to improve sales productivity, "we know that home is an important part of our ongoing omnichannel strategy."
The department store will add select boutiques to stores highlighting key manufacturers. Image: J.C. Penney.
While many of the boutiques Ullman's predecessor erected have since been dismantled, with only a few such as Sephora and Disney remaining, the CEO said the company is willing to try select models. Among those that will be tested will be "attractions like a Bassett shop inside our furniture department, and also Hallmark cards and gifts."
What it means for investors
All of the above shows that while the fourth-quarter earnings results were disappointing, the early sell-off in J.C. Penney's stock was misguided. Analysts who have questioned the company's prospects may need to adjust their expectations higher.
J.C. Penney actually grew sales and gained market share in the quarter despite a difficult and highly competitive retail environment. That's a source of accomplishment for the retailer, not shame, and the market will eventually take notice.
The article J.C. Penney Company: 5 Things Management Wants You to Know originally appeared on Fool.com.
Rich Duprey owns shares of J.C. Penney Company. The Motley Fool recommends Walt Disney. The Motley Fool owns shares of Walt Disney. 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.
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