If you are invested in any major department store retail equity you are well aware of the absolute beating exhibited on the sector over the last several months. Some retailers are faring better than others, but by and large most have been finding their retail operation and share price under increasing pressure over the last two years. I’ve followed and forecasted the probable stock performance for many of these retailers over this time including Bed Bath & Beyond (BBBY), J.C. Penney (JCP), Target (TGT), Macy’s (M) and Dillard’s (DDS) just to name a few.  It’s no fun and I make very few friends outlining the issues with these retailers that are difficult to fix and with initiatives offered to investors by said retailers that are to the detriment of shareholders.  In this retail sector update I will be discussing the issues plaguing J.C. Penney while reviewing the company’s Q4 2016 results and outlook for 2017.

As I had previously warned investors, J.C. Penney was peaking with regards to its turnaround efforts. Having produced negative comp sales results in 2 of 3 FY2016 quarters heading into the Q4 reporting season, there was little probability that the company was going to produce anything positive during the 4^th quarter. I offered such commentary and analysis of J. C. Penney’s struggling business in 2017 in the following articles linked below for easy access:

• J.C. Penney Share Price Has Followed Underperforming Same-Store-Sales Results 
• Is J.C. Penney's "Better" Days Behind The Retailer? 
• J.C. Penney Downgraded: Nike Partnership Not A Savior For The Retailer

Without any further ado, J.C. Penney did report a rather poor fundamental performance during the Q4 2016 period and FY16 as a whole.  Having said that, the company did meet its FY EBITDA goal, which is less of a consideration to investors. What JCP investors must recognize is what most institutional investors have recognized over the last 2-year period, “Retailers are being priced to sales, not earnings and/or profits”.  It has been with most department store retailers that as sales have fallen, earnings have fallen and the share price has followed.  While some retailers have been able to enact some aspects of financial engineering to prop up their stock performance, it ultimately succumbs to the pressure of the sales performance.  And J.C. Penney’s sales performance in 2016 was a far cry from what the company set out in its initial guidance for the year.  

For the fourth quarter, J.C. Penney comp sales were negative 0.7% versus last year; but on a two-year stack, the comp sales performance was a plus 3.4%. December was the best-performing month in the quarter.  The online business remained strong and delivered double-digit growth for both the quarter and the full-year. For the year, J.C. Penney achieved flat sales comps and a positive net income and over $500 million improvement for the year.

One of the biggest issues J.C. Penney has combated throughout 2016 has been apparel sales. That issue will likely continue to plague the company in the first half of 2016 and despite initiatives in place. All apparel categories, men's, kids' and women's performed below the company comp for the 4th quarter, with men's and kids' significantly outperforming the women's business.  During the quarter, J.C. Penney found sales floundering and was forced to engage more deeply in promotions and couponing. This resulted in a 100 basis point gross margin contraction on a YOY basis. For the quarter, gross margins were 33.1% of sales. With respect to the aforementioned growth in the online business, that growth came with a price as it impacted gross margins in a highly competitive marketplace. And if the online margin struggles weren’t enough the appliance business, which is growing nicely, also produced a negative impact to total gross margins during the quarter. In total gross margins decreased by 30 basis points in 2016 to 35.7% of sales.

For the sake of brevity I will touch on J.C. Penney’s online business by saying the retailer does not rank in the top 10 of retailers with an omnichannel presence. While the company campaigned to increase their assortment/sku count online in 2016, the business segment is not enough to offset what is happening in the way of declining foot traffic and transactions in-store.  Having said that, J.C. Penney is forced to move forward with the growth in its online strategy by increasing the assortment further in 2017.  In fact, in Q1 of this year, J.C. Penney has plans to increase the online sku assortment by over 140% versus last year.  For FY16, approximately 77% of all online orders touched a physical store. This is both a benefit and a detractor unfortunately and as the company is set to close some 140 stores in 2017. 

The store closure count represents between 13% and 14% of the current store portfolio, but less than 5% of total annual sales. While J.C. Penney offers that the store closures will result in a negative impact to gross margins of 15-20 basis points in 2017, they will likely be found to have understated the impact.  This expectation is included in the FY17 gross margin guidance. So let’s look at the guidance for 2017.

• Comparable store sales are expected to be down 1% to up 1%.
• Gross margin is expected to be up 20 basis points to 40 basis points versus last year.
• SG&A dollars are expected to be down 1% to 2% versus last year.
• Adjusted earnings per share are expected to be in the range of $0.40 to $0.65.

Regarding Q1 2017 and in review of the FY17 guidance offered, CEO Marvin Ellison did offer to analysts on the conference call that he is expecting Q1 comp sales to moderate to the lower end of the sales range.  I believe this was the smart way to approach an otherwise difficult entrance to the New Year and with some inventory overhang still to work through. But the FY guidance, even at the low-end of the range seems optimistic given the trends in retail as well as last year’s dramatic underperformance when compared to FY16’s initial sales guidance. Marvin Ellison has much work to do to gain credibility with analysts and investors in 2017 after last year’s performance.

Naturally, Mr. Ellison detailed the many initiatives the company has and continues to embark upon in order to return to sales growth and increase EBITDA.  Nike was offered as one of these such initiatives during the 4^th quarter only to be updated and to include the brand offering of Adidas merchandise, coming soon.  As I presciently warned investors in the past, be it with initiatives for Target, Bed Bath & Beyond or Macy’s, these initiatives must be valued based on their possibility to impact sales metrics incrementally.  Most of the time, these initiatives have little to no incremental impact to the business. Case in point would be the great many initiatives offered by Target back in 2015.  With a new CEO in place for Target the company outlined its strategy and focus for investors at its annual Financial Community Meeting.  I covered this meeting for investors and articulated the details from the meeting in an article titled Target Executives Outline The Retailer's Path To Future Growth.  The laundry list of seemingly intuitive and constructive initiatives and programs put forth by Target at that time bore little impact on the overall business and found Target producing a forecast for 2017 that takes earnings and sales near 2014 levels. 

Nike (NKE) nor Adidas will be incremental to the totality of J.C. Penney’s business.  At less than 500 sq. feet of retail selling place in any given store front, these popular brands can do little more than plug a hole in the leaking sales business that has been J.C. Penney for the better part of 2016. And remember how many popular National brands the company has introduced to its customers over the last 4 years. These brands have only brought the company to where it is today, with the expectation of -1-+1% comp sales in 2017. Those are just the facts sprinkled with a good deal of logic.

Moreover, I would greatly encourage investors to review the Target article linked and compare it to the initiatives and programs being detailed by J.C. Penney’s CEO.  I think you will find it uncanny the degree of similarity in the initiatives, programs and efforts. Where Mr. Ellison expresses the benefits of understanding who their customer is and how they shop, Target expressed the exact same effort and understanding of their then characterization of their core customer being a “demanding enthusiast” shopper.  J.C. Penney suggests their core customer is the “modern American mom, multicultural in her 30s”.  The plus size product offering to broaden the J.C. Penney product assortment and to reach a greater customer base, also offered by Target in 2015 and reemphasized in 2016 through many print and television advertisements. It’s not that I desire to find negative sentiment toward J.C. Penney’s initiatives; it’s just that this movie has played itself out already, and the end result is well understood.  It wouldn’t matter if I named Macy’s or Bed Bath & Beyond, they all offer initiatives to course correct the business trends, they all invest in different areas of the business to compete and they are all finding declining sales nonetheless.  The incremental impact to sales from J.C. Penney’s initiatives may be found wanting in the way there peers have experienced.

J.C. Penney has some great business segments and those segments continue to express strong growth. Unfortunately, like the initiatives outlined, not enough to grow sales in 2016 and only to the degree management has guided to an average of flat sales growth in 2017.  The apparel business is the biggest business to J.C. Penney. Nothing J.C. Penney has in the way of Beauty, Home and omnichannel offerings even comes close to its total apparel business segment.  It’s smart to segment the business as Mr. Ellison is spiriting in the way of appliances and services, but these efforts take extreme marketing and promoting, often don’t expand your customer base and detract from the core business in a cannibalizing way.  One can suggest Target’s venture into Target Canada helped to cannibalize its efforts in the United States. Macy’s efforts to monetize its real estate assets helped to cannibalize its core U.S. retail business. And so on and so on and so on.  Sometimes segmenting into new businesses and operations inhibit management’s focus on the biggest existing business segment and to the detriment of the business and shareholders.  Akin to Macy’s efforts to monetize its real estate assets, J.C. Penney is hoping to achieve $100mm in monetization of its real estate assets in 2017, which is baked into its guidance.