J.C. Penney (JCP) reported less than expected top-line growth for the Q3 2016 period while reporting in-line EPS expectations. Last week, the company issued 3^rd quarter results of ($.21) a share in earnings on $2.86bn in revenues. J.C. Penney’s 3^rd quarter earnings per share improved 42% to ($0.22) versus ($0.38) for the same quarter last year. Adjusted earnings per share improved 54% to ($0.21) per share for the 3^rd quarter of this year compared to ($0.46) per share last year.  The revenue miss of roughly $100mm also represented a 1.4% YOY decline in revenues.  The revenue miss came with a negative .8% same-store-sales result against an expected growth of 3-4% SSS result, which was also the guidance for the full year. That guidance has been lowered to exhibit SSS growth of 1-2% for the fiscal year. 

As we pivot our retail strategy towards these and other non-weather sensitive categories, we expect the strength in performance from these initiatives will help drive our fourth quarter comp store sales performance to be in the range of approximately 2% to 5%. Having said that, and given the softer than expected sales in Q3, we have updated our comparable store sales guidance on a full-year basis to now be in the range of a positive 1% to 2%.

One bad quarter is all it takes in this retail environment that finds total retail sales wavering month-to-month and with consumption occurring differently than in past years. It remains to be seen whether or not all the initiatives put into place by CEO Marvin Ellison will be incremental in this retail environment. For now and in response to the company’s reported results, investors seem more upbeat than the results would appear as JCP shares gained in price post missing revenue expectations for Q3 2016. 

Moreover, Mr. Ellison noted what impacted 3^rd quarter results that also found gross margins slightly lower than the year ago period.  Gross margin for the 3^rd quarter was 37.2% of sales, down 10 basis points on a YOY basis. Looking to the Q4 2016, J.C. Penney expects the gross margin rate will be up compared to the same period last year. All in all, FY16 gross margin guidance is now roughly flat compared to last year.

The impact on sales during Q3, now impacting SSS guidance for the full-year were/are as follows:

• Operational impact from building out the floor space in roughly 500 store fronts to include appliances.
• Weaker than anticipated apparel sales in most apparel categories.
• Sephora outperformance
• Appliance sales outperformance in October
• InStyle salon outperformance
• Unseasonable weather

Marvin Ellison noted that once all operations for placing the appliance department in stores was completed, the month of October proved to grow comps 200 basis points year-over-year.  This detail helped lift investor spirits and proved to rally shares of JCP.  Having said that, investors should recognize that one-month does not make a quarter. The same scenario presented itself in JCP Q2 2016 results where the company had a rough quarter with improving comps coming from the latter part of the quarter. The company failed to lower guidance then, under the guise of optimism for Q3 and Q4 SSS improvement, and even with the knowledge of the pending appliance roll-out.  So with continued pressures on SSS in Q3 2016 and abysmal SSS results, the company has finally lowered SSS guidance…again explaining why investors should remain as optimistic as management.  Fool investors once shame on you, fool investors twice… We shall see how Q4 2016 comes in with the backdrop of the election cycle now complete.

The omni-channel build-out has continued for J.C. Penney through Q3 and is likely to continue into the future.  The company outlined a broader selection of merchandise available through the company’s digital facing business format, a 40% increase in sku levels. Additionally, J.C. Penney will have buy online, pick up in-store available in all storefronts by the holiday season this year.  Given the number of initiatives ongoing, the appliance build-out completed for this year, continued strength in Sephora, center core and InStyle, the retailer has maintained its forecast for delivering EBITDA of $1bn this year.

I believed J.C. Penney would be lowering its sales outlook prior to the company’s official Q3 2016 report.  With that said, I’m none to keen on the company’s prospects for achieving 3% SSS CAGR results indicated by management during the conference call with investors and analysts. While the company’s 2-year stack SSS comp is impressive at roughly 4.5%, it came on the heels of some operational miscues and very low comps from previous years. Moreover, I believe the company’s dedication to eliminating some of the seasonal and weather related sales reliance is an optimal strategy, but I also believe the implementation of lower margin appliances will be a long-term headwind. Some existing businesses that are heavily reliant on appliance sales have proven to suffer from the categories reliance on macro-economic conditions. Sacrificing weather related goods for the sake of macro-economic sales driven goods seems…shortsighted. Given the state of this bullish economic cycle that is nearing its 8^th year of existence, it can be rationalized or hypothesized that J.C. Penney is getting into the appliance business at the peak of the economic cycle. This could prove problematic in the years to come, especially when giving up floor space that would definitively garner higher gross profit margins from national and private labels. Having said all of that, when you go from no presence in the appliance world to having a significant presence, near-term results from appliance sales should prove promising; they won’t be enough to offset weakness in apparel as proven already, but promising on their own account.

On Tuesday, investors will get another piece of data to chew on regarding not just J.C. Penney but the totality of retail sales and how department store retailers like J.C. Penney faired when compared to Nonstore retailers. On Tuesday, the Census Bureau will release October retail sales results at 8:30am EST.  Department store retail sales results have been abysmal when compared to Nonstore/e-commerce retail sales.  In my recent article titled “Retail Reporting Season Begins With Monthly Retail Sales Ahead” I offer the following: 

September’s monthly retail sales surged, however. Sales at retail stores, online retailers and restaurants rose a seasonally adjusted 0.6% in September from the prior month, matching economists’ expectations for a rebound after sales fell 0.2% in August. As it pertains to total retail sales, the department store contribution to the data has been paltry for some time now. The department store retailers have been showing YOY sales declines for the last 3 years. In the September retail sales data, department store retail sales fell by 6.4% and fell MoM by .7 percent.  With regards to the poorly performing department store segment of the retail sales data, one can draw a direct correlation to the outperformance from Nonstore retail sales (otherwise understood to be e-commerce sales).  In the September retail sales read, Nonstore retail sales grew 10.6% YOY, drawing more and more consumers and dollars away from traditional brick and mortar retailers.

J.C. Penney has come a long way since its steep declines from 2008-2012.  But even as they’ve improved greatly, they’ve acquired a great deal of debt along the way. When we juxtapose the fact that the retailer is still yet to become profitable against a potentially peaking economic cycle, the risks remain tall for investors and the brand.