Earnings Preview: Did Kohl's and J.C. Penney Weather the Storm in Q1?

In general, 2018 was a good year for department stores. However, growth started to slow again toward the end of the year, and that slowdown continued in early 2019. Furthermore, rising tariffs threaten to pressure gross margin at many retailers, leaving department stores with even less margin for error.

Last week, Macy's kicked off earnings season for the department store industry, reporting lower earnings despite a 0.7% comparable-store sales gain. On Tuesday, moderate-price rivals Kohl's (NYSE: KSS) and J.C. Penney (NYSE: JCP) are set to report their results for the first quarter. Let's take a look at what investors should be looking for in those upcoming earnings reports.

Kohl's looks to continue its momentum

Back in March, Kohl's forecast that comp sales would rise 0% to 2% in fiscal 2019, while adjusted earnings per share would reach a range of $5.80 to $6.15, up from $5.60 last year. However, management warned that Kohl's got off to a slow start in February. As a result, CFO Bruce Besanko projected that sales growth would be near the low end of the full-year range and gross margin would be flat or down slightly on a year-over-year basis in the first quarter.

Fortunately, retail sales bounced back in March. As a result, Kohl's may have outperformed its guidance. Analysts are calling for Q1 sales to be roughly flat year over year at $3.95 billion but for adjusted EPS to rise by $0.03 to $0.67, mainly due to the impact of share buybacks.

Investors will also be eager to hear more about Kohl's decision to begin accepting Amazon.com returns at all of its stores as of July. Kohl's has been testing this service in nearly 10% of its stores, but rolling out the program nationwide represents a big commitment -- and presumably indicates that the partnership was boosting the performance of its pilot stores. The potential upside in terms of sales growth is significant, but shareholders are still struggling to understand the impact of the Amazon returns program on Kohl's cost structure.

A recent report that Kohl's is exploring an acquisition of home decor chain At Home raises another set of questions. However, unless Kohl's announces a deal prior to its earnings report, executives are likely to remain silent on the subject during the earnings call.

Any signs of progress at J.C. Penney?

In contrast to Kohl's, J.C. Penney's performance went downhill last year. New CEO Jill Soltau, who took the reins back in October, now needs to clean up the mess.

Over the past few months, Soltau has taken a step in the right direction by hiring numerous senior executives to restock J.C. Penney's depleted management bench. However, she still hasn't laid out her turnaround strategy for the company. Shareholders will be listening eagerly to the earnings call in the hope that she will offer more details on her plans.

As for the first quarter itself, J.C. Penney's results could be pretty ugly. The retailer stopped selling appliances at the end of February, and the discounts necessary to clear out floor models likely hurt gross margin last quarter, adding to the pressure from the company's ongoing effort to reduce its inventory. Additionally, J.C. Penney's exit from the appliance business presumably negatively impacted sales in March and April.

Thus, analysts expect J.C. Penney to report a 4% decline in revenue to $2.56 billion, along with a wider loss of $0.38 per share, compared to an adjusted loss of $0.22 per share a year earlier. The real question is whether the company can give investors greater confidence that results will start to improve later in the year.

The tariff issue looms large

Analysts are sure to ask executives from both Kohl's and J.C. Penney about the potential impact of the growing trade war between the U.S. and China. The U.S. recently raised the tariff rate on $200 billion of Chinese imports from 10% to 25%, and it is threatening to impose tariffs on additional items later this year.

Chinese suppliers may bear some of the cost of these tariffs, but U.S. retailers are still likely to face meaningful cost increases unless they can easily find alternate suppliers outside of China. Retailers like Kohl's and J.C. Penney will then need to decide how much of the tariff burden to absorb and how much to pass through to customers. Of course, price increases (to cover the cost of the tariffs) could trigger a sales slowdown.

Kohl's has been posting consistent sales growth and modest margin expansion over the past year and a half. At worst, rising tariffs might take a bite out of its momentum. The stakes are higher for J.C. Penney, though. The iconic department store operator was plagued by falling sales and margin erosion even when the economy was firing on all cylinders last year. J.C. Penney can ill afford additional business headwinds. Investors should look out for any details on the expected impact of the tariffs during management's earnings call commentary.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Adam Levine-Weinberg owns shares of J.C. Penney, Kohl's, and Macy's. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.