Analysis: Despite setback, management taking Penney in right direction

JCP ended its last fiscal on a moderately upbeat note -- especially on the profit front, where it managed to push into the black. These first quarter results change the mood music to a much more somber tone and undoubtedly represent a setback in the company's recovery plans.
 
The 3.7% decline in overall sales, and the 3.5% decline in comparable sales which accompanies it, come off the back of weak comparatives from the prior year. Most of this slip is down to the fact that JCP failed to attract customers to its stores, especially during the early part of the quarter when traffic across the industry was weak. Although this trend eased toward the back end of the quarter, it underlines how important it is that JCP constantly markets itself, and communicates the changes it is making, to shoppers.
 
Many of the changes are paying dividends, even if their positive impact is overshadowed by weaknesses elsewhere in the business. The appliance category, for example, has seen growth and we believe this will continue to build as rivals like Sears struggle. A reinvigorated home offer, including improved store layouts and merchandising, has also been a success. The problem is that, on their own, neither of these initiatives has enough firepower to turn around the entire business.
 
A bigger gun that does give JCP more firepower is Sephora. At the end of last year, the Sephora shop-in-shop concept was in 577 JCP stores. Across this year, Sephora will be added to around 70 more stores. Moreover, all locations will be enhanced with the introduction of new beauty brands and, in the case of some stores, the addition of more selling space. The impact of having a popular beauty player as part of the offer cannot be underestimated. Without it, customer traffic and sales would have tumbled far further and faster; and JCP would have attracted far fewer younger shoppers.
 
The real challenge for JCP is how to persuade customers visiting Sephora to become loyal JCP shoppers who visit and spend in other areas of the store. This strategy is beginning to take shape with the development of more beauty services under the Salon by InStyle banner, some improvements in the womenswear offer, and the activities around the home and appliance category. In our view, it will take time for these initiatives to reach maximum potential.
 
The area in most desperate need of attention is fashion. Despite the enhancements made to-date, the offer is still not compelling enough to drive sales. Spring collections showed some signs of improvement, but there is much more work to do here if JCP is to turn this into a winning category.
 
Turning to the bottom line, JCP made an operating loss of $105 million -- much worse than last year's Q1 $22 million profit. However, the deterioration was the result of $220 million in restructuring charges from the store closure program. 
 
Given that this is an essential plank of restoring JCP to health, it is a necessary evil. Without these exceptional costs, JCP would have made an operating profit of $115 million. In our view, this points to the fact that Marvin Ellison and his team are gradually improving the operational and financial health of the business. Despite this quarter’s set back, we have confidence that they are taking JCP in the right direction.
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