J.C. Penney Is Alive. Now What?

By Markets Fool.com

While this past holiday season was a tough one for several of the nation's biggest retailers,J.C. Penneywas one of the surprising winners. The department store chain said sales at established stores increased 4.1% and reported its first quarterly profit since Ron Johnson dismantled the company back in 2012, with adjusted earnings per share of $0.39.

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Better yet, the company expects to report an adjusted profit for the current year on a 3% to 4% increase in same-store sales and $1 billion in EBITDA.

The results are the clearest sign yet that the company is on its way to recovering from the dark days of the Johnson administration, when same-store sales fell 25% in 2012. Johnson, who was the vision behindApple'sretail stores, had a grand vision for Penney, attempting a full-on rebranding that was met with confusion by the chain's middle-class customer base. Johnson got rid of proven traffic drivers such as discounts and house brands, and neglected the company's online business. His successors have spent the past three years cutting costs and making other moves to restore the company's health. Marvin Ellison, who landed in the CEO chair last August after revamping Home Depot's supply chain, seems to be the right man for the job after the latest report. Let's take a closer look at how Ellison is bringing Penney back from the brink.

Back to basics
On the recent earnings call, Ellison explained the company's multi-pronged approach to delivering long-term profitability.

  • Focusing intensely on value to bring back customers.
  • Bringing back house brands such as St. John's Bay and using in-store brands and services such as Sephora and newly rebranded In Stylehair salons as points of differentiation.
  • Repairing a broken omnichannel by improving its app and adding in-store pick-up, among other features to catch up to competitors.
  • Making better a use of data by updating pricing and selection accordingly, and using real-time responses to refine its marketing campaigns.

The retailer has also been taking advantage of new opportunities. It re-entered appliances for the first time in more than 30 years, challenging an ailingSears Holdings, a department store chain bleeding sales that could easily flow to J.C. Penney. The company is testing an appliance program in 22 stores and is cannily displaying demo models while keeping the inventory with vendors, saving on the traditional cost of retail. The company also sees distinct opportunities in Home, footwear and handbags, and posted its best comp sales growth in more than 10 years in Home last quarter.

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Low-hanging fruit
A recentFortuneprofile on Ellison underscored just how many seemingly simple opportunities there are for J.C. Penney to improve sales. For instance, Penney had for years, stocked its men's shoes in the women's footwear department, operating under the notion that housewives were doing the shopping even for their husband's footwear. Ellison put an end to that anachronism, moving men's shoes next to men's suits, and sales in the department increased by double digits. The company made a similar move to refresh its handbag line after noticing it missed out on the recent industry boom. Ellison has also found back-of-the-house areas like inventory management lacking. The company now replenishes inventory according to real-time data instead of at pre-scheduled times.

Picking the proverbial low-hanging fruit is easy, however, and decisions like the ones above seem to be how the company is improving comparable sales today. But beyond that, Penney still has two other major challenges. It occupies an industry, department store retail, that appears to be on the decline, and it is still saddled with billions in debt and steep interest payments that will hamper significant investments.

Where J.C. Penney stands today
Those years of losses have added up. The retailer currently has $4.8 billion in debt and over $400 million in annual interest expenses. In order to cover those interest payments alone, the company would have to deliver an operating margin of more than 3%. In other words, paying down the debt will go a long way toward driving profitability.

On the recent earnings call, CFO Ed Record said it would pay down $400 million to $500 million in debt this year as it prepares to sell its home office building.That's a sizable chunk of cash, but it will only reduce its borrowings by 10%. Meanwhile, the company is also considering a share buyback in the middle of the year as an appeasement to shareholders, focusing target debt-to-EBITDA ratio of 3. Paying down debt is a step in the right direction, but it will be a long slog.

As for the health of Penney's greater industry, it's clear that the company is taking sales from rivals such as Sears andMacy's, but department store retail sales as a whole declined by 2% last year, according to the Census Bureau. If the pie continues to shrink, the retailer may run into further problems once the low-hanging fruit is gone.

For now, however, Penney is in better shape than it's been in years, and its stock could have room to run as the recovery picks up. At $10 a share and a price-to-sales ratio of 0.23, the stock looks like a bargain for a healthy company.

The article J.C. Penney Is Alive. Now What? originally appeared on Fool.com.

Jeremy Bowman owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool recommends Home Depot. 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.