“This doesn’t end well,” is a phrase I’ve heard uttered several times by sports broadcasters, usually as a fighter has his opponent on the ropes. This phrase seems to apply perfectly to the current situation at J.C. Penney Company, Inc. (NYSE:JCP). The retailer has problems, and to be quite blunt, the company’s issues aren’t fixable in just a quarter or two. Shoppers have been leaving Penney in droves, and things aren’t likely to get better. Management needs to realize the company should be in survival mode, and yet that’s not happening either. The bottom line is, this doesn’t end well for employees or stockholders.
Honestly the biggest problem facing J.C. Penney Company, Inc. (NYSE:JCP) today is that the company is being forgotten. The old days of choosing between J.C. Penney at one end of the mall and Sears Holdings Corporation (NASDAQ:SHLD) at the other are gone. When companies like Kohl’s Corporation (NYSE:KSS), Target Corporation (NYSE:TGT), and Wal-Mart Stores, Inc. (NYSE:WMT) began opening standalone stores it was the beginning of the end.
Peter Lynch once said that the best measure of any retailer is their same-store sales. He suggested that it wasn’t a big deal to see a drop in same-store sales if the economy was bad or if the weather was unusual. However, when a retailer underperforms its peers on a consistent basis, you know there are bigger issues.
The biggest issue facing J.C. Penney Company, Inc. (NYSE:JCP) is their struggle when it comes to same-store sales. While the past several months were no great sales bonanza for most retailers, J.C. Penney clearly was the worst of the bunch, reporting a 16.6% drop in same-store sales. Of the company’s peers, Target Corporation (NYSE:TGT) actually performed the best with a same-store sales decline of just 0.60%. By comparison, Wal-Mart Stores, Inc. (NYSE:WMT) and Kohl’s Corporation (NYSE:KSS) saw same-store sales declines of 1.4% and 1.9% respectively.
I Thought Everyday Low Prices Were the Solution
It’s amazing to me that a retailer can change to everyday low prices and investors believe this is the solution to the company’s problems. What’s equally amazing is, when the company goes back to promotional pricing and sales, investors believe this is the solution to the company’s issues.
The truth of the matter is that J.C. Penney Company, Inc. (NYSE:JCP) is suffering primarily because shoppers have found other alternatives that offer similar or better quality, and better selection. This brings us to the second problem facing the chain: their gross margin is falling off a cliff. Last year, J.C. Penney commanded a gross margin of over 37%, which is similar to other large mall-based retailers. This year, the company’s gross margin dropped to 30.8%, which is only slightly better than Target Corporation (NYSE:TGT)’s gross margin of 30.7%.
While it’s true that J.C. Penney Company, Inc. (NYSE:JCP)’s gross margin is better than Wal-Mart Stores, Inc. (NYSE:WMT)’s at 24.66%, the latter has been focused on taking grocery market share, which is a historically thin margin business. Kohl’s Corporation (NYSE:KSS), on the other hand, still carries a gross margin of over 36% and seems to have taken J.C. Penney’s place, with higher normal prices and regular sales.
The double-edged sword of J.C. Penney Company, Inc. (NYSE:JCP)’s gross margin dropping is, they are unable to spread their fixed expenses across as large of a revenue base. This has caused the company’s SG&A to jump to nearly 41% of revenue. If this crazy level of expenditures isn’t a solid third reason to avoid the shares, I don’t know what is. To get an idea of just how far out of whack this is, consider that between Kohl’s Corporation (NYSE:KSS), Target Corporation (NYSE:TGT), and Wal-Mart Stores, Inc. (NYSE:WMT), the average SG&A percentage is just under 21%.
You Do Realize You’re Losing Money, Right?
The fourth and most troubling reason to avoid J.C. Penney Company, Inc. (NYSE:JCP) at the current time has to do with their cash flow and capital expenditures. In the last year, the company’s core operating cash flow (net income + depreciation) declined by over 400%.
By comparison, Kohl’s Corporation (NYSE:KSS) reported operating cash flow growth of 1.69%, and excluding Canadian expansion costs, Target Corporation (NYSE:TGT) reported cash flow growth of 0.86%. With Wal-Mart Stores, Inc. (NYSE:WMT) reporting a 2.32% increase in operating cash flow, we can clearly see that J.C. Penney is not only lagging their peers, but the situation looks extremely serious.
As if the decline in operating cash flow wasn’t bad enough, management decided that doubling their capital expenditures versus last year somehow made sense. The company is losing sales left and right, their gross margin is declining severely, and management at the top has just changed. Spending twice as much on capital expenditures appears to show a severe lack of judgment.