Despite the Huge Rally, J.C. Penney Isn't Out of the Woods

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General merchandise retailer J.C. Penney has been to the brink of collapse and back again. It's gone through a business restructuring, the unceremonious exit of a high-profile chief executive officer, and saw its sales fall off a cliff in just a few years.

After reporting first-quarter earnings, all of that seems to be a distant memory. Shares of J.C. Penney skyrocketed after a surprise increase in same-store sales. There seems to be a sense of euphoria that the company may finally have found a floor and that a meaningful turnaround could truly materialize.

It's certainly the case that J.C. Penney posted solid growth on the surface. But the company is by no means out of the woods. It's being given the benefit of the doubt for mere survival, which hardly seems like reason to celebrate. Only the most risk-tolerant investors should consider J.C. Penney because the company still faces a host of risks. If you're interested in a department store, you'd be better off buying Macy's .


Rewarded for survival
J. C. Penney shares soared after earnings were announced. While that might lure you into thinking the company is on the cusp of a return to greatness, that doesn't appear to be the case. J. C. Penney's 16% spike post-earnings looks simply like a relief rally amid massive short-covering. The company's underlying results were ugly and shouldn't inspire any confidence.

Its performance was better than feared, and the market essentially rewarded the company for lasting through another quarter. In all, comparable-store sales, which measure sales at locations open at least one year, rose 6.2%, which looks good. But it's important to note the extremely easy comparisons J.C. Penney faced. Put simply, the company's sales fell off a cliff for the past few years, which means going forward, it will enjoy the benefit of a very low base.

Despite its sales growth on a percentage basis, J.C. Penney's first-quarter total sales of $2.8 billion were still well below the revenue generated just a few years ago. Consider that J.C. Penney generated $3.9 billion in sales in the first quarter of 2011. That means that its sales have fallen 29% over the past three years.

In addition, J.C. Penney is still spending a lot of money on its restructuring. Elevated costs have eroded margins in that time frame as well. Three years ago, J.C. Penney's gross margin clocked in at 40.5%. The gross margin now stands at 33.1%, representing more than a 7 percentage point deterioration in margins.

Despite its rise in sales, J.C. Penney is no more profitable than it was last year. In fact, it actually lost more money in the first quarter of 2014 than it did in the first quarter last year. The company's net loss expanded to $352 million from $348 million, year over year.

J.C. Penney is still losing a lot of money, and better alternatives exist among department stores. For example, Macy's is solidly profitable, has demonstrated much more consistent growth over the past few years, and pays a dividend.

Macy's gross margin is 40%, and its diluted earnings per share are up 32% since 2011. To reflect its success, the company has increased its dividend five-fold in that time span.

No need to take the risk
The key takeaway is that while it may seem like J.C. Penney is finally out of the woods, proper context is necessary. Its huge rally after releasing earnings seemed more like a relief rally based on short covering rather than the beginnings of a real turnaround.

J.C. Penney was less profitable in the first quarter than it was in the year-ago period. It pays no dividend and offers very little downside risk. By contrast, Macy's is growing reliably and rewards its shareholders with solid profits and a dividend. There's simply no need to risk your money on J.C. Penney's questionable outlook when better, more profitable alternatives exist.

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The article Despite the Huge Rally, J.C. Penney Isn't Out of the Woods originally appeared on Fool.com.

Bob Ciura has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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