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J.C. Penney's Fight for a Turnaround

NEW YORK (TheStreet) -- Investors want to know one thing when J.C. Penney (JCP) reports third-quarter earnings on Wednesday: Was this the quarter when the company finally had some real turnaround?

The Plano, Texas-based retailer is expected to post a loss of $1.77 a share for the third quarter, according to Thomson Reuters, nearly double the 93-cent loss of a year earlier, but narrower than the $2.16 a share adjusted loss J.C. Penney reported for the July-ended quarter.

Revenue is expected to fall 5% to $2.79 billion. And while no retailer ever wants to see declining quarterly sales, it's far better than the 26% sales drop in the third quarter of 2012 and the 12% decline in the second quarter.

J.C. Penney has been publicly noting improved sales within its business -- last month it reported the first positive monthly comps in nearly two years. But the question is how much of that has come at a price? In other words, has the company been executing significant promotions in order to get shoppers in the door and even online?

"With shares already pricing in improved sales momentum, we remain fixated on what merchandise margin levels have been that has driven the improvement and the strategy of balancing promotion and sales in (the fourth quarter)," Deutsche Bank analyst Paul Trussell wrote in a Nov. 18 note. "We believe JCP will continue to recover lost top-line and margin, but we remain cautious on the pace."

Deutsche Bank has a "hold" rating on J.C. Penney.

PiperJaffray analyst Neely Tamminga believes J.C. Penney's loss will be wider than consensus estimates due to "margin degradation."

Tamminga reduced her loss estimate to $2.05 a share in a Nov. 17 research note. While the analyst believes improvements in J.C. Penney's e-commerce sales added momentum to the company's comparable-sales story, same-store sales likely fell 4.5%, the note said.

In addition, "gross margin likely de-levered owing to lower clearance margin rates, an increase in clearance units, and an increase in promotional pricing," Tamminga's note said. 

Tamminga has a "neutral" rating on the stock.

"We remain in true neutral territory on this stock but note that the recent commentary around conversion rate improvements driving the positive 'comp' in October intrigues us, in that, conversion tends to be a good leading indicator of a sustained positive turnaround (provided traffic does in fact eventually come back)," Tamminga wrote. "We also note with interest the company having repositioned their home department in select store checks this month -- giving us hope that the holiday quarter may be able to sustain a positive 'comp.'"

Consumers have been averse to apparel shopping for the most part this year. Retailers, of course, blame a struggling consumer or the weather, meaning sometimes it's too hot to think about winter clothes or it's too cold to think about summer clothing. But as the weather turned cooler in the last few weeks of the third quarter, it seemed that shoppers began to hit the stores in stride and a big part of that were the sales and promotions retailers had in an effort to get rid of piling up inventory and clear the space for fresh merchandise for the holiday season.

Last week, Macy's (M) reported a slightly lower margin in the third quarter, which it attributed in part to increased shipping costs as part of its "omnichannel" customer experience. But investors didn't seem to care given the retailer blew past consensus expectations on both the top and bottom line in the third quarter.

Macy's said it expects continued pressure on its margin in the fourth quarter but it hopes to offset that with lower SG&A expenses.

Which brings us to the other issue investors will want to know about at J.C. Penney: How's the holiday season looking? Can whatever J.C. Penney said about the first few weeks of sales in November infer anything about the most important quarter of the year?

Kohl's (KSS) reported disappointing third-quarter earnings and lowered expectations for the final quarter of the year, due in part to lower store traffic. However, CEO Kevin Mansell said the company is "well positioned" to take market share during the holiday season.

Will J.C. Penney be able to do the same?

J.C. Penney shares have been beaten up this year. The stock is off 55% as the company tries to reverse losses that culminated under its previous CEO Ron Johnson. Johnson was replaced in April by Mike Ullman, ironically Johnson's predecessor. J.C. Penney also had to contend with one very noisy and very large shareholder, Bill Ackman of Pershing Square Capital, who pushed for a faster turnaround but ultimately gave up his board seat in August and sold out his entire stake.

The company has had to secure billions in extra liquidity as it seeks to restore its business and get customers coming back to the store.

Yet the stock seemed to be recovering somewhat this month. Shares are up 16% since Oct. 31, helped by news that several hedge funds including Appaloosa Management, Farallon Capital and activist investor Jana Partners picked up stakes in the retailer's stock last quarter.

That said, shares were down 3.5% on Monday, closing at $8.71 on rumors via social media that the stock could be removed from the S&P 500.

J.C. Penney and S&P didn't respond to emailed requests for comment.

Written by Laurie Kulikowski in New York.

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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