While it may seem like a “broken record” statement it is also the reality and that reality offers that J.C. Penney (JCP) finds itself continuing to struggle. The retailer's quest for stability during a seismic shift in retail consumption has been a daunting challenge for the department store brand. These struggles were evidenced yet again in the retailer’s Q2 2017 results.

J.C. Penney recorded revenues of $3bn, up 2.7% YOY while beating analysts’ estimates by roughly $160 million. The headline sales growth looks relatively strong, but the underlying same-store-sales (SSS) comp still expressed negative sales growth. Same-store-sales fell 1.3% during the 2^nd Quarter, improving significantly since falling 3.5% in the 1^st Quarter. With J.C. Penny closing some 130 stores during the 2^nd Quarter, the impact on the SSS results was 20 basis points, which would bolster the SSS comp to negative 1.1% had that operation not been found necessary.

The sales breakdown on a monthly basis is as follows: Low-single digit negative comps in May/June and approximately flat comps in July. The July comp is significant when you consider that J.C. Penney was comping against a nearly plus 4% comp from July of 2016. The strong comp for July has carried into early back-to-school selling season per management’s discussion with analysts and media participants. Sales were a mixed bag of puts and takes. Unfortunately, J.C. Penney managed to miss EPS estimates by reporting ($.09) against analysts’ estimates of ($.05) for the Quarter. And with that, the stock plunged to a new 52-week low trading price. 

J.C. Penney managed to increase units per transaction and average unit retail ticket versus the same period a year ago. Having said that, traffic was still negative year-over-year as recognized through declining transactions. On a regional basis, the Southwest and Southeast were the best-performing regions of the country and the Northeast was the worst performing region.

Margins definitely impacted J.C. Penney Q2 results, as the company did not appropriately forecast the impact on gross margins from closing some 130 stores. Other areas of the business that pressured margins relative to the retailer’s expectations were shrink and the continued growth in both online sales and major appliance businesses. Margin for the 2^nd Quarter was 35.1% of sales, a decline of 200 basis points year-over-year. The liquidation events for closing stores pressured margins by approximately 120 basis points in the quarter and far more than anticipated. This was a gross miscalculation by management that likely impacted the tenure of the outgoing CFO. But all members of management should shoulder the blame. Nonetheless, the impact from store closures on the gross margin rate in the 2^nd Quarter has forced the retailer to restate its forecast for gross profit margins in FY17. The previous guidance called for an increase in gross profit margins of 20-40 basis points over 2016. J.C. Penney has now adjusted this expectation downward by offering they expect the full-year margin rate to be in the guided range of down 30 basis points to 50 basis points. The worst part of this egregious miscalculation in forecasting metrics is that it seems to be an ongoing problem from J.C. Penney. The company has consistently missed its forecast for SSS over the last 5-6 quarters. Generally, such a trend finds itself negatively reflected with investor confidence and a lesser share price valuation.

Moreover, it’s not all bad news when it comes to gross profit margins. It’s important to recognize that the impact on gross profit margins from the store closing and liquidation event is a 1-time variable. Secondly, merchandise margins in go-forward stores were up over 140 basis points year-over-year, as J.C. Penney continue to see benefits from their ongoing margin initiatives such as pricing analytics, modernizing replenishment process and systems and improving the profitability of private brands through design, sourcing, and speed to market initiatives. Such initiatives combined w/not carrying forward unprofitable stores should prove beneficial for J.C. Penney in the back half of 2017 and early periods of 2018. 

J.C. Penney is still repairing itself and that process will likely play out through 2018.  There are a great many initiatives related to operations, store formats and merchandise assortment. The company now has over 600 Sephora inside J.C. Penney shops and opened a total of 70 locations in 2017. In the 3^rd Quarter, 38 of these new locations will open. This will allow the retailer to end the year with nearly 650 locations or approximately 75% of stores will have a Sephora. Fenty Beauty by Rihanna will also be launching in Q3 and will be exclusive to Sephora.

Apparel, the beating heart of J.C. Penney sales continues to decline YOY with no expectations to turn positive in 2017 as noted by management. For this reason and to the benefit of shareholders the company continues to modify its apparel assortment. J.C. Penney did experience sequential comp improvement in all of its apparel performance, specifically in kids, but even so, total apparel still underperformed the company's comp in the 2^nd Quarter. This means apparel sales were down at least 1.4% year-over-year, at least. So let’s take a look at what management offered regarding the go-forward strategy for bringing relief to declining apparel sales:

As you know, women's apparel is a significant percent of our overall revenue, and that business has been under significant pressure for the last year-plus. And although, we're excited about home initiatives and beauty, we also are laser-focused on fixing the women's apparel business. And although, we're not going to give the specific comp, we can tell you that the business improved. And some of the liquidation decisions we made were strategic and they were planned because we wanted to free up the ability of the merchants to land product for back-to-school and the fall season that's more active and more contemporary.

And lastly, we continue to improve and strategically adjust our apparel categories with an emphasis on fixing our women's apparel business. In the past, J.C. Penney has been over-assorted in traditional women's clothing and under-assorted in casual and contemporary women's clothing.  In the second quarter, we took aggressive steps to liquidate some of the less desirable apparel inventory to make room for the expansion of the more casual and contemporary women's apparel being launched for back-to-school and the fall season.

And the first step in converting women's apparel to a more casual environment was to increase our penetration in activewear, and we're accomplishing this by expanding our relationship with Nike (NKE) and Adidas, while providing our customers a great opening price point option with our active wear private brand, Xersion.

Much of the liquidation of merchandise that occurred outside of store liquidations came from the company’s dedication to the noted apparel strategy. The company has decreased inventory levels mightily during the Q2 period. Inventory was down 6.8% in the 2^nd Quarter. To put this into perspective, the comp store inventory declined approximately 3.7% in the quarter. I laud J.C. Penney for recognizing they must repair their apparel business if they hope to capture greater foot traffic and benefit from the other departmental initiatives put in place already. What I still can’t find an appreciation for regarding the many initiatives put in place by J.C. Penney is the utter lack of marketing surrounding these initiatives. I’m forced to recognize that as the retailer cuts expenses while ramping initiatives, there is a cross current of futility. The initiatives sound great and look great in stores, but with declining eyes trafficking stores what could the value of these initiatives bring long-term. That doubt surrounding this retailer’s ability to forecast appropriately while undergoing numerous changes is also reflected by many investors in the share price performance over the last year or so.  It’s that doubt I speak of that carries forward with respect to the lack of meaningful change to J.C. Penney’s FY17 guidance. Let’s take a look:

• For fiscal 2017, comparable store sales are expected to be down 1% to up 1%.
• Cost of goods sold is now expected to be in the range of up 30 basis points to 50 basis points versus last year.
• SG&A dollars are expected to be down 1% to 2% versus last year.
• Adjusted earnings per share is expected to be in the range of positive $0.40 to $0.65
• Free cash flow guidance at a positive $300 million to $400 million.

So as we look at our guidance for the back half, we're very confident that we can hit our guidance, the growth initiatives, and the improvement in business give us that confidence.

As apparel sales go, over the long haul, so will J.C. Penney. The majority of the retailer’s sales still come from its apparel categories. The problem for such a business model is that there does not exist the notion of “fixing” apparel sales.  For any clothing retailer it is well known that this is an ever-present and ongoing part of the business. Apparel sales wax and wane with the ever-changing trends in fashion and the fickleness of the consumer.  It’s for this reason the terms “collection and pods” reign heavily over the apparel and accessory industries. Every season has a new collection/pod and retailers hope that these new collections/pods resonate with consumers. So when J.C. Penney discusses “fixing” its apparel business it would prove wise for investors to revisit the company’s history as this is a constant discussion centered on brief periods of apparel sales success that are followed by brief periods of failures. 

There is yet another struggle that is misunderstood or misrepresented by retailers and the media with regards to the seismic shift toward online sales and away from brick and mortar storefronts. Don’t get me wrong, this is occurring and at an accelerated pace in recent years. But even so, some 20+ years since online retailing began the category only accounts for 8.5% of total retail sales. Ten years ago, online sales accounted for only 2.5% of total retail sales. The jump to the present market share represents a $300bn surge in online retail sales and Amazon (AMZN) is the largest participant in the sales channel. With this important fact in mind, there is another variable that has constantly siphoned sales away from brick and mortar retailers yet it rarely, if ever, gets recognition from analysts and the media.

Americans’ consumption needs and preferences have changed significantly. Ten years ago we spent a pittance on mobile phones. Today Apple (AAPL) sells roughly $100 billion worth of “i-goods” in the U.S., and about two-thirds of those sales are iPhones. Apple’s U.S. market share is about 44%, thus the total smart mobile-phone market in the U.S. is $150 billion a year. Add spending on smartphone accessories (cases, cables, screen protectors, etc.) and we are probably looking at $200 billion total spending annually on smartphones and accessories. Verizon Communications’s (VZ) wireless-generated revenue in 2006 was $38 billion. Fast-forward 10 years and it is $89 billion — a $51 billion increase. Verizon’s market share is about 30%, making the total spending increase on wireless services alone close to $150 billion. Between smartphones and their services, $340 billion will not be spent on T-shirts and shoes. 

As one can see from the noted factual representations in consumer spending, brick and mortar retailers will have continued difficulties competing for consumer dollars. J.C. Penney Q2 store closings were definitely a 1-off event and a necessity. But what is concerning about the profit outlook that hasn’t changed is a good portion of sales’ initiatives impact gross margins negatively. Both appliance sales and e-commerce sales have a negative YOY impact on margins and these are some of the key areas of growth for the company. There is no guarantee that as the women’s apparel assortment changes to become more on-trend it will drive greater foot traffic, conversion and average ticket. Changes in the apparel assortment don’t change iPhone sales and wireless service consumption. And given the poor performance with regards to forecasting I would be of the opinion that investors will continue to vote their shares with great doubt surrounding the unchanged profit guidance. 

With that said, from the sales side it does appear as though absent store liquidations sales are moving in the right direction even if only for a brief period.  CEO Marvin Ellison and his executive team are obviously hoping that increased sales volumes will offset the impact on gross profit margins to a degree it doesn’t impact the EPS forecast. It all sounds promising, but that promise will be met with increased promotional activity in the back half of the year for retailers. So we’ll have to wait and see if Mr. Ellison and his team can resurrect investor sentiment and overall trust.