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Why You Should Steer Clear of JC Penney

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The retailer continues to struggle with its switch to an everyday low prices policy, and any real turnaround could still be years away.

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Coupons were a drug. They really drove traffic.
-JC Penney CEO Ron Johnson

JC Penney (NYSE:JCP) CEO Ron Johnson showed more signs of deviating from his iron-clad policy of eliminating discount sales Monday, when the company announced that it will offer deep price cuts on certain items as part of this year's Black Friday kickoff to the holiday season.

The move came after the company recently emailed customers a $10 "gift" to use when they make a purchase at one of its newly redesigned stores. That's a coupon by any other name, though JC Penney denies this.

"This invitation is in no way a reflection of a departure from our fair and square everyday low prices," JC Penney spokesperson Kate Coultas told the Wall Street Journal.

JC Penney Posts Its Fourth Consecutive Losing Quarter

Either way, it's unlikely that the timing of these announcements-bookending the release of more disappointing earnings from JC Penney-is a coincidence.

In the company's third quarter, which ended October 27, 2012, its sales fell 26.6%, to $2.93 billion from $3.99 billion a year ago. That was well short of the consensus forecast of $3.27 billion. Same-store sales fell 26.1%, and online sales dropped 37.3%.

On an adjusted basis (excluding gains on sales of non-core assets, restructuring charges and a non-cash pension plan expense), JC Penney lost $203 million, or $0.93 a share, compared to a profit of $38 million, or $0.18 a share. That was well off the $0.07-a-share loss that analysts were expecting. The company's gross margins also fell to 32.5% from 37.4%.

Everyday Low Prices Strategy Is a Road to Nowhere for JC Penney

Penney has now been mired in red ink since it swung to a loss in the third quarter of 2011. Since then, the stock has slumped more than 40%. And that's not the only way its investors have suffered: back in May, the company suspended its $0.20-a-share quarterly dividend.

JC Penney is using the annual savings of $175 million from the dividend cut for its restructuring, which involves switching from frequent sales on items to an everyday low prices strategy. The company hopes this approach will lure customers to its stores more often, knowing that they are always getting the best deal, instead of holding out for sales.

The strategy is the brainchild of Johnson, who was hired to spearhead the company's restructuring a year ago. He was formerly head of merchandising at Apple (NASDAQ:AAPL), and is credited with the enormous success of the company's Apple Stores. Before that, he was vice-president of merchandising at Target (NYSE:TGT).

The coupon addiction is proving a tough one for Johnson to break, since the company's customers are well-trained to look out for deals before coming in. The abandonment of discount sales also deprives JC Penney of a key tool to drive customer traffic.

What's more, the recent one-offs, such as Johnson's $10 "gift" and the Black Friday sale, which he says will feature "some of our lowest prices ever," are undermining the new approach and further confusing the company's customers.

JC Penney Is Running Out of Runway

The second part of Johnson's restructuring involves opening "stores within stores," or separate stand-alone outlets within the company's department stores. This move is garnering wider success. It started with Sephora beauty boutiques in 2007, and Johnson is also setting up outlets for Levi's, Martha Stewart, and the Canadian Joe Fresh fashion brand.

The concept is performing well: Johnson has said the Sephora boutiques have produced 5% same-store sales increases "independent of the JC Penney performance."

The problem? The conversion won't be fully rolled out until 2015. That means the retailer will have to find a near-term solution to its falling sales. Whether that means a return to coupons-as hinted at by the two recent promotions-remains to be seen. But either way, there's no sign that JC Penney is going to pull out of its slump anytime soon.

In another bearish signal, the short sellers are circling; JCP is now the second-most shorted stock in the S&P 500 (INDEXSP:.INX). (Short selling involves borrowing shares of a company and selling them immediately with the hope of buying them back at a lower price at a later date.) Right now, 40% of Penney's public float is sold short, behind only solar power equipment maker First Solar (NASDAQ:FSLR), at 47%.

Two Retailers With Brighter Prospects Than JC Penney

A mid-sized retailer with far brighter short- and long-term prospects is Dillard's (NYSE:DDS), which operates 284 outlets and 18 clearance centers in 29 states. It also sells goods through its website.

Dillard's reported its third-quarter results last week, and they are almost exactly the reverse of Penney's: excluding unusual items, Dillard's earned $46.1 million, or $0.96 a share, in the three months ended October 27, 2012. That's up sharply from $25.7 million, or $0.48 a share, a year earlier. Same-store sales rose 5%, and overall net sales gained 4.8%, to $1.45 billion.

The company's gross margin from retail operations was 37.1%, up from 36.7% a year ago.

The stock is up 35.5% this year yet still trades at a reasonable 13.2 times the company's last 12 months of earnings, comparable to competitors like Kohl's Corp. (NYSE:KSS) and Macy's (NYSE: M).

Wal-Mart (NYSE:WMT) also remains in a strong position to benefit during the holiday season and beyond. The company-which pioneered everyday low pricing-dominates the industry, with 10,130 stores worldwide.

Wal-Mart continues to build its online presence and expand into the grocery market by adding to its chain of Neighborhood Market stores, which offer a full line of food items, including baked goods, frozen food and local produce. Wal-Mart now operates 220 Neighborhood Markets. It aims to more than double this to 500 by its 2016 fiscal year.

The shares are up 13.5% in the past year and have lots of growth potential ahead as the economy rebounds. The company also pays an attractive dividend: quarterly payments of $0.40 a share yield 2.19% on a yearly basis.

This article by Chad Fraser was originally posted on Investing Daily.

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