Bringing Back Sales May Not Bring Back Profits at J.C. Penney

On Monday evening, J.C. Penney CEO Ron Johnson told the Associated Press that his company would reintroduce some sales this year, particularly around holiday events. Investors greeted the news with relief, sending the stock as much as 10% higher on Tuesday. The move to reintroduce sales is probably a good decision. However, bringing back sales is not guaranteed to return J.C. Penney to profitability. Accordingly, investors should wait to see tangible signs of a turnaround before buying the stock.

The background
Last year, J.C. Penney controversially eliminated most sales and coupons in an attempt to simplify operations and improve the company's profit margin. However, the elimination of discounts was a disaster. Through the first three quarters of fiscal year 2012, revenue was down 23% to $9.1 billion, while the company's GAAP loss widened from $0.30 per share to $1.98 per share. On an adjusted basis, EPS for the first three quarters dropped from $0.73 to negative $1.55. Analysts currently expect another dreadful performance in the fourth quarter, with revenue down more than 23% even though the quarter has an extra week compared to last year!

This rapid deterioration of operating results was unprecedented in the retail industry. While Ron Johnson understood that a sudden change in pricing strategy could alienate some customers, he believed that most customers could see through the "gimmicky" nature of markups and markdowns in the retail industry. Instead, customers abandoned J.C. Penney in favor of competitors like Macy's and Dillard's that maintained a promotional stance while offering high-quality merchandise. These competitors managed to post 3% to 4% same-store sales growth in spite of a weak retail spending environment by taking share from J.C. Penney.


A shift foreshadowed
J.C. Penney returned to moderate promotional behavior in the past few months. During the back-to-school period, the retailer offered free children's haircuts in its salons. This promotion returned during the holiday season, along with a $10 "gift" to entice customers into the stores, a friends-and-family discount day, a Black Friday sale, and other promotional events.

J.C. Penney's management studiously avoided referencing "sales" or "coupons" while communicating about these events. Nevertheless, J.C. Penney had clearly begun a move back toward the promotional model before this week's announcement.

What does the change mean?
There are two possible interpretations of the "return to sales" at J.C. Penney. The first is that revenue has remained extremely weak in the fourth quarter, in spite of the added promotional activities. This has forced management to throw in the towel and return to a reliance on promotions as the primary driver of store traffic. Alternatively, the decision could be evidence that the limited return of promotions in the fourth quarter drove better revenue results. In this scenario, J.C. Penney is just extending its holiday-season strategy to the rest of the year.

Rather than buying the stock now, investors might want to wait to learn which of these story lines is true when J.C. Penney reports fourth-quarter earnings later this month. Macy's and Dillard's are formidable competitors; J.C. Penney will have a hard time regaining the market share it lost as a result of its strategy shifts. Therefore, the company needs to demonstrate revenue momentum in order to become a viable investment candidate.

Investors are invited to claim a copy of The Motley Fool's new must-read report on J.C. Penney. Learn everything you need to know about JCP's turnaround -- or lack thereof -- and as a bonus, you'll receive a full year of expert guidance and updates about the company as key news develops. Simply click here now for instant access.

The article Bringing Back Sales May Not Bring Back Profits at J.C. Penney originally appeared on Fool.com.

Fool contributor Adam Levine-Weinberg is short shares of Dillard's. The Motley Fool owns shares of Dillard's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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