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Has J.C. Penney Finally Hit Rock Bottom?

J.C. Penney (NYSE: JCP) has burned many investors over the past three years as its stock lost over 90% of its value. Yet the decline repeatedly attracted bottom-fishing investors who believed that the retailer could eventually recover.

All those investors caught falling knives, and the stock rests near an all-time low, well below $1 per share. However, J.C. Penney's stock recently rallied slightly after faint flickers of life appeared in its second-quarter report. Let's see if those improvements indicate that J.C. Penney's stock has finally bottomed out.

A J.C. Penney store.

Image source: J.C. Penney.

First, the bad news...

J.C. Penney's revenue fell 7% annually to $2.62 billion, which matched analysts' expectations. Its comparable store sales declined 9%, marking its fourth straight quarter of negative comps growth.

Metric Q2 2018 Q3 2018 Q4 2018 Q1 2019 Q2 2019
Comps growth 0.3% (4.5%)* (4%)* (5.5%) (9%)

Source: J.C. Penney quarterly reports. *Shifted basis.

Excluding the impact of its exit from the major appliances and in-store furniture categories, its comps fell 6%. The decline was mainly attributed to a lower number of transactions, which was partly offset by a "slight increase" in average transaction size.

J.C. Penney reported strong demand for fine jewelry, women's apparel, men's apparel, and footwear, but that growth couldn't offset weaker sales of its home goods, women's accessories, and children's apparel. Competition from Amazon, superstores like Walmart, discount retailers like TJX, and fast-fashion retailers like Zara continues to be a problem, and sluggish mall traffic is exacerbating that pain.

J.C. Penney expects its comps to decline 7%-8% for the full year (which ends on Feb. 2), or 5%-6% after excluding appliances and furniture. This indicates that its declines might have bottomed out in the second quarter, but it's unclear when its growth will turn positive again.

Now the good news...

Since taking the top job last October, CEO Jill Soltau has focused on dumping J.C. Penney's lower-margin departments (like furniture and appliances) and aggressively clearing out its inventories to make room for new products.

The checkout counter at a J.C. Penney store.

Image source: J.C. Penney.

That's why the company's inventories declined 12.5% annually to $2.47 billion during the quarter. Its exit from furniture and appliances, along with fewer markdowns, also reduced its cost of goods sold from 66.3% of sales to 63.2%. It stated that both its clearance and non-clearance margins improved year-over-year.

J.C. Penney's credit income rose 64% annually to $110 million on the strength of its credit portfolio, but it doesn't expect that growth to continue in the second half of the year. However, that boost, along with its selling margin improvements, enabled J.C. Penney to post an operating profit of $17 million during the quarter, compared to an operating loss of $36 million a year earlier.

Its adjusted net loss narrowed from $120 million to $56 million, or $0.18 per share, beating expectations by $0.13. Those bottom-line improvements indicate that Soltau's focus on "sustainable and profitable" growth is gradually paying off. It reduced its long-term debt from $3.96 billion to $3.56 billion, and it expects to generate positive free cash flow for the full year.

It shuttered 15 full-line stores (out of its 18 announced closures for 2019) and nine Home and Furniture locations during the quarter. To lure more low-end shoppers back to its stores, J.C. Penney launched a new partnership with thredUP, an online marketplace for secondhand clothing, to bring its apparel to 30 stores.

J.C. Penney expects its adjusted EBITDA to decline 16%-23% for the full year, but that rate was distorted by a one-time gain of $70 million from asset sales last year, as well as $20 million in extra home office lease expenses this year. Excluding those one-time benefits and charges of $90 million, its adjusted EBITDA would only dip about 4% annually.

So has J.C. Penney hit rock bottom?

J.C. Penney's report was more encouraging than Macy's (NYSE: M) latest report, which featured decelerating sales growth, tumbling earnings, and a bleak forecast for flat comps growth and a 30% earnings drop for the full year.

But it also doesn't indicate that J.C. Penney is out of the woods. J.C. Penney's bleeding is slowing down, but its comps and EBITDA growth remain negative, and it still remains vulnerable to rising tariffs. I wouldn't touch J.C. Penney until it generates a few consecutive quarters of positive comps growth with expanding margins -- which might convince me that it can avoid the fate of its deeply troubled rival Sears Holdings.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Leo Sun owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends The TJX Companies. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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