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What Kohl's and J.C. Penney Executives Are Saying About Weak Q1 Earnings

On Tuesday morning, J.C. Penney (NYSE: JCP) and Kohl's (NYSE: KSS) became the latest department stores to report dismal first-quarter results. Comparable-store sales fell 3.4% at Kohl's and plummeted 5.5% at J.C. Penney. As a result, Kohl's recent streak of earnings growth ended, while J.C. Penney's loss more than doubled year over year.

These results were even worse than what analysts had been expecting. This added to investors' anxiety about department stores' future prospects. Shares of both retailers have fallen more than 20% over the past month, with most of the damage coming this week.

J.C. Penney and Kohl's 1-Month Stock Performance, data by YCharts.

Not surprisingly, both companies' leaders spent most of their respective earnings calls trying to reassure investors. Here's what they had to say.

Tentative progress at J.C. Penney

The headline numbers at J.C. Penney were quite poor. Moreover, management indicated that shareholders should expect comparable-store sales to continue falling at a mid-single-digit pace for the rest of fiscal 2019, roughly speaking. That said, J.C. Penney executives pointed to several signs that the struggling department store chain is on the right track, particularly with regard to margin improvement.

First, CEO Jill Soltau noted that the company ended the first quarter with inventory down 16% year over year. As a result, inventory is selling faster and nonclearance gross margin is rising. CFO Bill Wafford added that J.C. Penney has started to cut down on "shrink" -- lost or stolen merchandise -- by increasing its usage of security tags.

Gross margin still declined by 50 basis points last quarter. However, that included a 70-basis-point headwind from liquidating most of the company's inventory of appliances and furniture, as J.C. Penney shifts its focus to higher-margin merchandise categories. Excluding appliances and furniture, gross margin increased. This gross margin expansion could accelerate over the course of the year as J.C. Penney starts to capitalize on its improved inventory position.

Second, Wafford pointed out that while selling, general, and administrative (SG&A) expenses rose $30 million year over year in Q1, a variety of one-time items affected that number. Underlying SG&A spending actually decreased by about $15 million.

J.C. Penney's Q1 loss looked a bit worse than it really was. Image source: J.C. Penney.

Third, Soltau stated that J.C. Penney removed hundreds of thousands of vendor-shipped items from its website last quarter with a negligible impact on sales. This will contribute to the company's efforts to focus on driving sales of the most in-demand items.

Kohl's is banking on a second-half recovery

Over at Kohl's, management blamed the sales slowdown on three factors: unseasonal weather, a decline in home sales due to elevated competition and a lack of exciting new products, and lower productivity from some key promotional events. Weak sales trends have continued into May, causing Kohl's to significantly reduce its full-year guidance.

CEO Michelle Gass acknowledged that Kohl's will always be a weather-sensitive retailer due to its merchandise mix. However, she said that the company is taking swift action to address the other two issues.

In the home area, new products should drive stronger results in the second half of the year. Most notably, Kohl's will expand the availability of Amazon.com (NASDAQ: AMZN) smart-home products to more than 600 stores and launch the Scott Living brand for home decor. Kohl's also plans to tinker with its marketing and become more aggressive on pricing to stay competitive and bolster its market share.

Gass also highlighted the company's returns partnership with Amazon as a key factor that will drive a rebound in sales growth. Kohl's has been accepting unpackaged returns for Amazon in more than 100 stores, but this service will be rolled out to the rest of the chain in July. Kohl's has seen a big increase in traffic in its test stores.

Investors were left with a lot of questions

A big reason why shares of Kohl's and J.C. Penney were hit so hard after earnings is that while both management teams projected confidence about improving results, there were only limited signs of tangible progress. Crucially, sales trends haven't improved yet at Kohl's, and J.C. Penney executives expect sales to remain weak all year.

Additionally, J.C. Penney CEO Jill Soltau hasn't presented a turnaround plan yet. She will have little margin for error, given that J.C. Penney is far from breakeven and has a weak balance sheet. Meanwhile, Kohl's sales-driving initiatives like ramping up promotions and accepting Amazon returns will put pressure on gross margin and operating expenses, respectively. Thus, even if these moves succeed in revitalizing sales, they could still hurt profitability, at least in the short run.

Thus, to own shares of J.C. Penney or Kohl's right now, you have to trust management -- the headline numbers simply aren't good. At least in the case of Kohl's, the company has a solid track record. By contrast, J.C. Penney shareholders need to have a lot of faith in what is still an unproven management team.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Adam Levine-Weinberg owns shares of J.C. Penney and Kohl's. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.


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