Can J.C. Penney Weather a Market Downturn?

J.C. Penney (NYSE: JCP) has been a bit of a retail conundrum. The company has struggled, but it has not fallen to the depths of its chief rival, Sear Holdings (NASDAQ: SHLD).

While Sears has had to sell itself off in parts in order to keep its doors open, J.C. Penney has in some ways expanded. The chain did close 140 stores in 2017, but in turn it added appliance sales to more than half its locations. It has also added toy departments in all of its stores and it has begun to offer home services in markets that Sears has abandoned.

J.C. Penney is not in a good space. Its loss doubled in Q3, going from $67 million last year to $128 million in 2017. That's, of course, bad news, but comparable-store sales did increase by 1.8% in the quarter. In addition, much of the loss can be attributed to selling off merchandise at heavy discounts as part of a strategy to change the chain's inventory mix.

Things remain precarious for J.C. Penney, but there are signs it has a strategy that will work. The problem is that the company has struggled for so long that a market downturn could put its recovery at risk.

Where does J.C. Penney stand?

CEO Marvin Ellison has been optimistic and believes his turnaround strategy is working. He explained away the Q3 loss and shared some thoughts on the future in his remarks in the Q3 earnings release.

"During the third quarter, we took aggressive actions to clear slow-moving inventory, primarily allowing for an improved apparel assortment heading into the holiday season," he said. "While these actions had a negative short-term impact on profitability in the third quarter, we firmly believe it was the right decision for the company as we transition into the fourth quarter and fiscal 2018."

The same-store sales increase and success with its Sephora store-within-a-store concept, as well as its revamped salons suggest Ellison may be right. The problem is that the company has a big hole to climb out of.

J.C. Penney has $185 million in cash and equivalents on hand. That's $2 million up from the same quarter a year ago, but the company's overall financial picture is exactly the same. It has $8.7 billion in assets and $8.7 billion in debts. In Q3 2016 it had $9.3 billion in assets as well as debts.

What this shows is that the company has been very careful with its money. It's not Sears, which has seen its assets dip well below its debt, but it's still walking a tightrope. J.C. Penney does not have a CEO like its rival that can loan it hundreds of millions of dollars.

Its ability to borrow continues to hinge on whether banks and other lending institutions believe it can pay the money back. The same is true for whether vendors will ship it merchandise.

The current balance sheet is enough to appease both of those key constituencies. A market downturn, however, could change that and make it hard for the chain to get access to capital or the inventory it needs to keep its doors open.

What's next for J.C. Penney?

"Our growth strategies and new apparel initiatives led to sequential comp sales improvement in nearly all merchandise categories in the third quarter, giving us confidence that our overall strategy and transformation is beginning to take hold," said Ellison. The CEO also noted that work remains, but that he believes the company is on a path to profitability.

That's true, but it does not acknowledge how vulnerable J.C. Penney remains. It's on a path to recovery, but a market downturn or even an increase in customers moving to the internet puts that recovery in jeopardy. This is a chain that has made the right moves, but it still has to walk a tightrope in order to give itself the breathing room to survive a market downturn.

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Daniel B. Kline has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.