J.C. Penney Company, Inc. Earnings: A Return to Profitability (Sort Of)

By Adam Levine-Weinberg Markets Fool.com

During 2015, J.C. Penney (NYSE: JCP) managed to post solid sales growth, even as most of its competitors began to face revenue declines. In 2016, J.C. Penney continued to outperform most of its peers in terms of sales performance. However, it was no longer able to completely buck the trend of sales declines that has been devastating the retail industry.

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Yet while comp sales ultimately came in well below the company's original forecast of a 3% to 4% annual increase, J.C. Penney still managed to reach some of its other financial goals in 2016. Most notably, it earned a full-year profit. Cost cuts are now driving the bulk of J.C. Penney's recovery -- and that will remain true in 2017.

J.C. Penney earnings by the numbers

On Friday morning, J.C. Penney reported that revenue fell for a second straight quarter in Q4. Comp sales slipped 0.7%, brought down by a poor performance during the first three weeks of November. This drove the bulk of the company's 0.9% revenue decline.

Gross margin also declined unexpectedly during the fourth quarter, due to higher promotional activity, presumably related to the slow sales in early November. Nevertheless, adjusted EPS jumped 64% last quarter, as J.C. Penney continued to slash its costs. For the full year, adjusted EPS reached $0.08, marking J.C. Penney's first annual profit in five years.

Metric

Q4 2016

Q4 2015

Change (YOY)

Revenue

$3.96 billion

$4.00 billion

(0.9%)

Comparable-store sales

N/A

N/A

(0.7%)

Gross margin

33.1%

34.1%

(100 basis points)

SG&A expense ratio

23.4%

24.1%

(70 basis points)

Adjusted EPS

$0.64

$0.39

64%

Free cash flow

$670 million

$775 million

(13.5%)

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Data source: J.C. Penney Q4 earnings report. YOY = year over year.

However, it's important to note that J.C. Penney sold its headquarters building and surrounding land for $353 million last quarter. As a result, it realized a significant one-time real estate gain in its Q4 results. Otherwise, its earnings would have been much lower.

Additionally, J.C. Penney produced a paltry $3 million of free cash flow last year, down from $131 million a year earlier. As recently as November, the company had been projecting that free cash flow would rise in 2016. The shortfall hampered J.C. Penney's debt reduction efforts.

Store closures come to J.C. Penney

J.C. Penney is following a common strategy to improve results going forward: downsizing. In conjunction with its earnings release, the company announced plans to close 130 to 140 of its roughly 1,000 stores in the next few months. It will also close two distribution centers.

J.C. Penney will primarily close smaller stores that are significantly less profitable than the corporate average. Sales are shrinking at many of these locations and it isn't cost effective for the company to make the necessary investments to get sales growing again at these stores.

J.C. Penney will close at least 130 stores this year. Image source: J.C. Penney.

In the long run, J.C. Penney expects the store closures to be neutral relative to net income. However, a slimmed-down store portfolio will enable the company to cut overhead expenses even further and will reduce its future investment needs.

Looking ahead

J.C. Penney is beginning 2017 with a much more realistic sales outlook. Management expects comp sales to be roughly flat this year. Gross margin should rebound by 20 t0 40 basis points, driven by better inventory management. Meanwhile, operating expenses will decline again.

As a result, J.C. Penney has forecast that adjusted EPS will surge to a range of $0.40 to $0.65 this year. Moreover, the company will be profitable without relying on real estate gains, as it did in 2016. Free cash flow should also bounce back as J.C. Penney realigns its inventory.

J.C. Penney's turnaround remains fragile. However, the long-struggling department store chain continues to make gradual progress toward sustainable profitability.

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Adam Levine-Weinberg owns shares of J.C. Penney. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.