How to Make J.C. Penney Fashionable Again to Investors

NEW YORK (TheStreet) -- How did J.C. Penney (JPC) fall from riches to rags? It failed to adapt.

But there are ways for the company to turn itself around and become fashionable for investors again. Penney shares, at around $9, are down nearly 6% for the year to date. It has very high short interest, too.

First and foremost, Penney’s needs a niche. It already has the powerful brand and wide distribution channels. But it must differentiate itself from its competitors including Kohl's (KSS), Macy's (M), Target (T) and Wal-Mart (WMT). And for that it needs to do more data mining in order to attract shoppers on what they want rather than on what they need, all year round. It won't be easy.

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J.C. Penney should also find opportunities to decrease its cost of goods sold, or the cost of the materials used in creating the goods along with the direct labor costs used to produce them. Penney’s cost of goods sold has steadily increased over the years and now stands at 70%, noticeably higher than Macy's (59%) and Kohl's (63%).

The root cause of J.C. Penney's growing COGS is increased amounts of merchandise sold on clearance and its focus on non-value-added costs such as haircuts and photography. A high quantity of merchandise sold on clearance is a direct symptom of an inadequate demand planning process. When a company's cost of goods sold steadily increases year after year (4.6% in 2012 and 2.17% in 2013) because of clearance sales, something is obviously broken.

Another issue that J.C. Penney needs to address is its high SG&A costs relative to sales, encompassing 34% of total revenue compared to Macy's (30%) and Kohl's (21%). J.C. Penney's larger SG&A percentage of revenue is partially due to its declining sales coupled with the fact that SG&A is only a partially variable cost; it is more difficult to decrease SG&A than a fully variable cost such as the brand of shirts sold.

If Penney were able to increase its revenue by 32% to get back to its 2012 levels while only increasing SG&A by 2% then SG&A would run at 25% of current sales -- not an impossible scenario considering that Kohl's SG&A runs at 21% of sales.

J.C. Penney recently secured $2.35 billion of credit to help in its restructure and pay its short-term debt. That’s fine but one has to wonder how many "turnarounds" the company will have before it falls by the wayside.

Bottom line, J.C. Penney needs to implement an effective demand planning process using data mining, find its niche in the marketplace and then focus advertising dollars on this niche.

Reducing its COGS and SG&A by only 9% each so that it aligns with its competitors' average of 61% and 25%, respectively, would save the company a whopping $1.12 billion annually and result in a near-breakeven year.

This is not an impossible feat -- its competitors are doing it right now.

At the time of publication, Fanara did not hold any positions in the companies mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

TheStreet Ratings team rates PENNEY (J C) CO as a Sell with a ratings score of D. TheStreet Ratings Team has this to say about their recommendation:

"We rate PENNEY (J C) CO (JCP) a SELL. This is driven by multiple weaknesses, which we believe should have a greater impact than any strengths, and could make it more difficult for investors to achieve positive results compared to most of the stocks we cover. The company's weaknesses can be seen in multiple areas, such as its generally high debt management risk, disappointing return on equity, poor profit margins, generally disappointing historical performance in the stock itself and deteriorating net income."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • The debt-to-equity ratio is very high at 2.03 and currently higher than the industry average, implying increased risk associated with the management of debt levels within the company.
  • Current return on equity is lower than its ROE from the same quarter one year prior. This is a clear sign of weakness within the company. Compared to other companies in the Multiline Retail industry and the overall market, PENNEY (J C) CO's return on equity significantly trails that of both the industry average and the S&P 500.
  • The gross profit margin for PENNEY (J C) CO is currently lower than what is desirable, coming in at 33.06%. Regardless of JCP's low profit margin, it has managed to increase from the same period last year. Despite the mixed results of the gross profit margin, JCP's net profit margin of -12.56% significantly underperformed when compared to the industry average.
  • JCP's stock share price has done very poorly compared to where it was a year ago: Despite any rallies, the net result is that it is down by 48.31%, which is also worse that the performance of the S&P 500 Index. Investors have so far failed to pay much attention to the earnings improvements the company has managed to achieve over the last quarter. Naturally, the overall market trend is bound to be a significant factor. However, in one sense, the stock's sharp decline last year is a positive for future investors, making it cheaper (in proportion to its earnings over the past year) than most other stocks in its industry. But due to other concerns, we feel the stock is still not a good buy right now.
  • The change in net income from the same quarter one year ago has exceeded that of the Multiline Retail industry average, but is less than that of the S&P 500. The net income has decreased by 1.1% when compared to the same quarter one year ago, dropping from -$348.00 million to -$352.00 million.

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