Is J.C. Penney's Comeback in Trouble?

After approaching the verge of bankruptcy in 2013,J.C. Penney(NYSE: JCP) has made a remarkable comeback. During 2016, it earned its first full-year adjusted profit since 2011 -- yet its sales momentum petered out as the year progressed.

In this episode ofIndustry Focus: Consumer Goods, the team discusses the company's plans to reinvigorate sales and cut costs in 2017 and beyond. They also evaluate the sustainability of its profits.

A full transcript follows the video.

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This podcast was recorded on Feb. 28, 2017.

Vincent Shen:Let's go to J.C. Penney. How did the results look?

Adam Levine-Weinberg:J.C. Penney actually has been an interesting case within the retail industry. J.C. Penney had a really terrible performance starting around 2012. It had a new management team that came in about five years ago. They decided they were going to get rid of coupons and get rid of discounts for the most part, because they wanted to bring in some big brands, which they did, including Michael Graves andDisney. And they thought these brands weren't going to come into the store if they were constantly offering $10 off a $10 purchase coupons. Getting the brands in was probably good, however, it wasn't worth what they did to their business by getting rid of the coupons.

They alienated the vast majority of their customer base. They saw sales declines, at one point, that were over 30% on an annual basis. They basically went from being an over $17 billion retailer in 2011 to being a $12 billion retailer two years later. In the past two years, J.C. Penney has actually been making a bit of a comeback. In 2015, it was the only department store chain that was posting good comparable store sales increases during the year. At the same time, it was still losing money because it was still relatively early in this comeback process.

So, in 2016, J.C. Penney actually made it into profit territory. In the fourth quarter, it earned adjusted EPS of $0.64. Full year EPS: $0.08. So, a very small bit of profit but profit nonetheless. That said, it ran out of steam in terms of comparable store sales gains, it was basically flat for the full year and actually down in the fourth quarter. Looking ahead to 2017,J.C. Penney's management expects pretty similar comp sales performance, roughly flat. They're hoping to do better, but based on the recent trends, they are being realistic and understanding that even with all the initiatives that they put into place to try to drive sales, so far, it's not really working. Or, to the extent that it's working, it's just offsetting the pressure that they're seeing elsewhere.

The profit is supposed to continue improving this year. They're looking for EPS of $0.40 to $0.65. But, as is the case with Macy's, a lot of this projected profit is coming from real estate gains. They're planning to sell off a couple of real estate assets that are, basically, they're not making full use of. One is adistribution facility that they have in the LA area. By selling this off, they can get a big chunk of cash and either move to a cheaper facility or consolidate into their other existing distribution facilities, and take that money and use it to pay off debt.

Shen:So, when it comes down to it, J.C. Penney, after looking pretty strong in 2015, as you mentioned, picking up a little bit of momentum with the turnaround process, even though they couldn't escape some of the broad trends that are affecting the industry. You mentionedsome of the better usage of its real estate, some asset sales. What else do you think the company is going to be focused on in the coming year? They've been doing a lot of cost-cutting, expense management. Do you think that this is going to be a focus, also?

Levine-Weinberg:J.C. Penney is looking to cut costs again in the coming year. The big news recently is that in conjunction with the earnings announcement last week, the company said that it's going to close between 130 and 140 stores by June. That's 13% to 14% of their store base. So, that's a pretty big number. It's mostly smaller and lower volume stores. They've said that even though it's 13 to 14% of the stores by number, it's actually less than 5% of their sales. So, these are less efficient locations, so by closing them, J.C. Penney hopes to capture some of that business in other stores or online. And they also just don't see it as being very profitable stores going forward. So, this will allow them to invest in their better-performing locations.

One of the other things you're seeing is that they're trying to add new departments to their stores thatthey think have better prospects going forward. In particular, you're seeing them try to reduce their focus on apparel sales because it's highly seasonal and highly weather-dependent. In the past few years, retailers have really had a lot of trouble with ordering cold weather gear and then it's not cold, or they order spring stuff and there's a cold spell in March. So, J.C. Penney's management is kind of tired of this. They will obviously continue selling lots of clothing, but they don't want to be so reliant on that that their earnings plunge whenever there's unexpected weather events. So, some of the big things you've seen are appliances, which they've started adding to stores last year. They just finished ruling that out, and they're going to continue adding that in some more stores during 2017. They're interested in other home initiatives -- flooring, curtains, all that kind of stuff.

Shen:So, basically, the core idea being, for example, this fair weather we've had in the past week, at least in the D.C. region, 70 degrees, it can be really tough to make your orders and stock your inventory based on that when the weather changes on you, for sure. Otherwise, my question for you, this, you mentioned, was its first full-year profit since 2010?

Levine-Weinberg:2011 on adjusted basis, 2010 on a GAAP basis.

Shen:Do you think it's fair to say that the company has finally broken through in its post-Ron Johnson turnaround, at the point where it's past the point of really stumbling along, and now they're looking forward and really focused on how they can return, or at least try to return, to their previous levels of revenue and their size and scale?

Levine-Weinberg:Yeah, I think that's true to some extent. I don't think J.C. Penney is ever going to get back to the size that it once was. But the company definitely has a plan for how it's going to reduce its debt, reduce its risk, save on interest expense. It has these brewing initiatives mainly in the home department, but also some other things, larger sizes, areas where they think they can compete better. I think that will allow them to carve out a niche for themselves. That said, it's important to recognize that they're still barely profitable. We are nearing the end of one of the longest-running economic expansions in U.S. history. Not a very strong expansion, but when the economy has been growing for eight years straight, that should be a time when you're making a lot of money. If you're only barely profitable then, there's going to be a recession sometime, we don't know if it's going to be in one year or three years or five years, but it's going to come sometime, and the question is, will J.C. Penney be in a strong enough position by then that it can survive a downturn? Or will it continue to be at this barely breakeven, in which case a downturncould be difficult to cope with.

Adam Levine-Weinberg owns shares of J.C. Penney and Macy's. Vincent Shen has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Walt Disney. The Motley Fool has a disclosure policy.