J.C. Penney Stock's Road to Recovery

Over the last few years, it's been a rough ride for investors in shares of J.C. Penney (JCP) Still, the stock is up 47% in 2016. Is this company on the road to recovery?

On Aug. 17, J.C. Penney held an analyst meeting that laid out its recovery plan. CEO Marvin Ellison has done a wonderful job stabilizing the company. In 2010, J.C. Penney had sales of $17.8 billion. Sales bottomed in 2013 at $11.9 billion. Now, three years later, the company is forecasting sales of $13 billion. While that's a long way from the nearly $18 billion in sales the company once had, it's still up almost 10% from the bottom in one of the toughest retail environments in memory.

Even more impressive than the sales recovery is the rebound in earnings before interest, taxes, depreciation and amortization. EBITDA bottomed out in 2013 with a $641 million loss. Today, the company sees adjusted EBITDA at $1 billion.

Ellison has focused on several important trends to bring customers back into the stores. The company is looking at filling unmet needs in certain demographics, like the increase in the Hispanic population, by catering to their needs.

J.C. Penney is targeting the "special size" community, since management believes 38% of the U.S. population wears a special size. That market is expected to grow by 50% in the next 10 years.

The appliance market is a $38 billion market and is forecast to grow 32% to over $50 billion by 2020. The company is also expanding its home offerings by selling window coverings, Empire flooring, Ashley Furniture, and various soft goods.

And finally, the beauty industry is projected to grow at an annualized growth rate of 4% to 5% through 2020. The company's ownership in Sephora is leading the charge into the beauty business.

Management believes it can grow these segments by 42% from $1.2 billion in 2017 to $1.7 billion by 2019. That incremental revenue should help reinvigorate the company's top line.

J.C. Penney is also updating its technology to capture more consumer dollars. Approximately 40% of customers who order online to pick up in store then make an additional in-store purchase. Approximately 50% of online orders become store traffic. Management is working hard to drive those online customers into the store.

J.C. Penney has also rebuilt its entire supply chain. The company believes it can deliver to 95% of the country within 2 days and 99% of the country within three days.

By restructuring its supply chain, the company is able to take advantage of localized inventory planning and allocation. By improving its distribution systems J.C. Penney is minimizing mistakes and avoiding unnecessary markdowns.

Second-quarter earnings were actually pretty good. The company reported comparable-store sales were up 2.2%, gross margin was up by 10 basis points, expenses were down by $48 million and adjusted EBITDA rose by $95 million.

But three weeks ago, J.C. Penney reported a somewhat disappointing third quarter, with a loss of 21 cents per share, one cent worse than the consensus estimate. Revenue fell 1.4% to $2.86 billion, slightly less than the $2.95 billion consensus.

The biggest disappointment was the comp sales decline of 0.8%, vs. an anticipated 2% rise. The comp was below the company's prior outlook of 3% to 4%. J.C. Penney blamed the miss on the disruption caused by the rollout of appliances in 500 stores.

Management said comps picked up later in the quarter after the appliance rollout was completed. Stores that sell appliances have overall better performance. Because of the company's experience in selling appliances, management felt comfortable giving guidance so that analysts modeled comps between 2% and 5% for the fourth quarter.

Gross margins fell 10 basis points to 37.2%. Margins were softer because of additional markdowns. The gross margin forecast should begin to improve as the company is lapping several quarters of terrible margins.

Obviously, the department store business is very tough right now. But if J.C. Penney can catch a few breaks, I think the stock can go higher, regardless of valuation.

In my opinion, a solid fourth quarter will get this stock over $11 a share and get some excitement back in the shares.

This article is commentary by an independent contributor. At the time of publication, the author held no position in the stocks mentioned.

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