Brick and Mortar J.C. Penney's Turnaround Is Right on Schedule

By Sean O'

Back in December, I put together a piece where I posited that J.C. Penney's turnaround attempt, while not an easy task, was proving successful up to this point, and would likely see the retailer back to some semblance of its old self by the end of the decade. While not particularly outlandish at the time, it definitely would have been bold of me to say that just one to two years earlier. J.C. Penney was on life support, particularly in 2013, and many predicted that it would be going the way of Sears Holdingsin the not-too-distant future.

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J.C. Penney's first store in Brooklyn, NY opened August 2014. Source: J.C. Penney 2014 Annual Report.

Since those dark days, and under the leadership of now re-retired CEO Mike Ulman, who came out of retirement to save his beloved mall-based retailer, the ship has begun to turn away from the iceberg. Its reversal has been so impressive that I concluded my article by stating that J.C. Penney needed same-store sales growth through the end of the decade of just 3.16% (how's that for precision?) to generate total sales of $14.49 billion, and EPS of $1.70 in FY 2020. Luckily for my reputation (I occasionally get something right, as do blind squirrels), J.C. Penney reported fourth-quarter and full-year results just a few days ago, and the turnaround is, indeed, right on schedule.

Recent resultsIn case you were wondering why shares of J.C. Penney popped more than 16% following its full-year and fourth-quarter earnings release, the answer is simple: The results were just that good.

Same-store-sales growth for the full year came in at 4.5%, and 4.1% for the fourth quarter. The chain boasted free cash flow of $131 million, full-year gross margins of 36%, up from 34.8% last year (which is just where JCP needs them to be), all on sales of $12.625 billion. Looking ahead to FY 2016, J.C. Penney's management guided for comparable-store sales growth of 3% to 4%, expanded gross margins of at least another 40-60 basis points, EBITDA of more than $1 billion, and positive earnings per share (not seen since FY 2011).

With results like this, it's little wonder the stock has continued to rise, and now trades up 29% from its value pre-earnings release. What investors should really be asking themselves is why they -- or more probably, day-trading algorithms, thus answering my own question -- didn't see this coming.

Why the JCP train is on the right trackThe graveyard of dead retailers is not a small one. In the litter are names we all have emblazoned in our minds within the nexus of retail history: Big Bear Stores, Galyan's Trading Company, Circuit City, and Radio Shack immediately come to mind. I hope it's not lost on the reader that J.C. Penney nearly found itself going the way of these and so many other retailers before it. But the righting of the U.S.S. J.C. Penney has been in the making for well over two years now, and the numbers on February 26th were the result of that hard work, effort, and reflection as to just how JCP fits into an world.

Revenues actually bottomed out in FY 2013, at $11.850 billion. J.C. Penney has been closing unprofitable stores, is now actually generating cash from operations, and expects same-store sales growth to be just where it needs to be to meet its goals in the coming year.

Why you're really reading this articleThe burning question -- because I know that you, dear reader, are not just a fan of retail history for its own sake -- is whether or not J.C. Penney has a place in one's portfolio. That's obviously a question only the individual can decide, but here are a few thoughts:

  1. JCP's turnaround is humming along nicely, and the best estimates I've seen call for EPS of $1.70 by FY 2020. What's it worth at that point -- 10 times earnings? Fifteen times? It's up for debate, especially because there are still long-term questions about what the retail landscape will look like in the year 2025 or 2030 (which is an important question if one truly is an investor for the long haul). Were JCP to be valued at 10 times its theoretical $1.70 EPS in 2020 -- four years from now -- that would imply annualized gains from its current $10 share price of just more than 14% -- well above average stock-market returns, and obviously pretty darn good. That is, until one takes a look at the rest of the retail landscape.
  2. J.C. Penney has operationally trailed peer Macy'sfor years now. Macy's is a brand that continues to pump out ample profits, returns on equity capital, and billions in free cash flow year after year. Macy's trades for an extremely attractive valuation, and is arguably better positioned for the digital age thanks to its omnichannel and supply-chain expansion initiatives.

These moves are going to become increasingly important in the decades ahead. For value-minded investors looking to dive into the retail sector due to recent share-price movements, J.C. Penney is a decent option; but buying into its return to glory is by no means a necessity.

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Sean O'Reilly has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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