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Analysis: Penney has the right captain, but the ship she inherited has holes

There’s no nice way of saying it: J.C. Penney was one of the losers over the holidays. Sales continue to be eroded significantly, with total revenue down by 7.7% and comparables down by 7%. Both slides come off the back of declines in the prior year and are the latest in a long line of deteriorating numbers. This quarter, the bottom line was in the black with a $102 million operating profit, although $73 million of interest expense meant that this translated into a relatively meager $25 million of net income before taxes.

Some of the sales decline is down to a deliberate pullback from certain categories, such as appliances. When this is accounted for, comparables dropped by 4.7% – a less steep decline, but one that still places JCP firmly in the losers' camp. The good news is that stepping back from low-margin products has allowed a 200-basis point improvement in the cost of goods sold, which is a chink of light in an otherwise gloomy set of results.

Although we recognize the work Jill Soltau and her team are undertaking to improve J.C. Penney’s position and attractiveness, the reality on the ground is that most stores deliver an experience that is well below par. They are messy, crowded with bland merchandise, and lack any energy or inspiration. It is, therefore, hardly surprising that many shoppers are abandoning them and taking their business elsewhere. Despite attempts to understand consumers better, JCP’s management has yet to stem this tide. And doing so will be difficult as it will require radical change and impactful marketing to inform lapsed shoppers of the improvements. Both things require capital and a strong balance sheet, neither of which J.C. Penney has.

None of this is to say that improvements have not been made. It would be unfair not to recognize that JCP has a new energy since Ms. Soltau took the reins; it’s just that this energy is very much diluted by the time it gets down to the shop floor. While there has been a clear reduction in inventory, shop floors are still too densely packed with stock. While some own-label brands have been revamped, they still lack coherence in terms of display and merchandising. And while there has been talk about adding more services to stores, this has not found its way to most of JCP’s outlets. Sadly, all of this gives us the impression that JCP is being given some pain relief pills when it desperately needs a blood transfusion and multiple organ transplants.

Part of the future solution must be to cut dead wood from the company which includes shuttering underperforming stores, especially those which are in malls where investments will not generate returns. As such we welcome the decision to close at least six more shops across this year, although we question whether this goes far enough. By shrinking the business, resources can be directed to those locations that do have a future. If the kind of thinking that has been demonstrated in the trial store in Hurst, Texas can be applied to other locations, the business may see some meaningful results.

It is important to recognize that none of the issues are caused by Ms. Soltau. She inherited them and is now sorting them out. In our view, she is the right person to do so and is the best prospect JCP has. We remain impressed by her customer-centric views, her commonsense approach to retailing, and by her experience in the industry.

Indeed, there is no doubt that JCP is on a better heading because it has a captain who understands the waters of retail. However, its ship is not in good shape and has several holes. With many waves threatening to overwhelm it, whether the craft remains seaworthy or at the bottom of the ocean remains to be seen.

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