Sterne Agee analysts Charles Grom, Renato Basanta, and John Parke delve into J.C. Penney, personally walking through stores and giving their impressions.

J.C. Penney Company JCP

We recently walked some J.C. Penney Company, Inc. (NYSE:JCP) stores and came away feeling that the company has taken positive steps toward righting the ship and is close to completing the implementation of the “Ron Johnson reversal” strategies it has outlined in recent months. As a result, traffic is improving, although we see no significant inflection yet and no clear indication that Penney can achieve MSD comp levels needed to steer well clear of liquidity issues. Our key takes follow.

Key Take #1: Traffic Levels = “OK”: Walking several NY/NJ stores in recent weeks, our feeling is that traffic has been modestly improving, particularly considering somewhat better weather trends since mid February. Interestingly, we learned that Penney’s had been honoring coupons/promos valid for days that were heavily impacted by severe weather subsequent to expiration (at the discretion of store managers). As seen with almost every other retailer, weather has had a pronounced impact on sales, and we believe placating Penney’s deal-driven customer is the appropriate course of action in this case, although some associates quipped about customers only coming “with a coupon in hand” despite weather. Net, our eye test says that traffic is starting to respond to some of the merchandising/promotional changes, but we see no significant inflection yet.

Key Take #2: Home on The Mend… Slowly. Our observations suggest that home reordering/remerchandising is close to being complete, though some kinks still need to be worked out. To this end, mostly gone are the “store-within-a-store” shops in home with most products now grouped by classification (versus brand). Specifically, space formerly allotted to Michael GravesBodin, and Martha Stewart “shops” has been allocated to juicers/blenders, coffeemakers, and frames/candles, respectively, while half of Jonathan Adler has been replaced by Royal Velvet. Perhaps equally important, J.C. Penney Company, Inc. (NYSE:JCP) has significantly toned down the “contemporary/modern” feel with regards to home furnishings, with a much more balanced assortment that includes traditional furniture congruent with the tastes/purchasing habits of Penney’s core shopper. Notably, we learned that the company returned to a commission-based compensation structure in Home this past weekend – an incremental positive, which, when teamed up with (1) the aforementioned placement/grouping/product changes, (2) a refocused marketing push (“Home Collection” theme to go live on March 13), and (3) a lay-up on the compares after last year’s closings/disruption (~300+ bps drag to 1Q13 SSS), should help boost results. Conversely, improvement could prove to be slow as “Johnson regime” signage and bulky fixtures (limiting sight lines) remain in stores today. All told, patience still needs to be the prime virtue for Penney investors when it comes to Home.

Key Take #3: She Wants That Old Thing Back. For the first time in a long time, we felt like we were back in an old (yet new) J.C. Penney Company, Inc. (NYSE:JCP). To this end, the company has made significant progress bringing back its iconic brands such as St. John’s Bay, for which we saw significant, fresh inventory, and Ambrielle, which is now back in most stores complete with new (nondescript) signage meant to alert customers of its availability. Importantly, in terms of brand placement, a.n.a. and J.C. Penney Company, Inc. (NYSE:JCP)  have replaced Joe Fresh at the front entrance of the store in women’s apparel, as the underperforming Joe Fresh brand has been moved away from the entrance/perimeter and right-sized to be more aligned with customer demand. Interestingly, a similar change was made in children’s apparel with the Total Girl brand replacing Joe Fresh in some mall-facing entrances. Finally, from our observations, the company is indeed moving quickly to purge stores of the discontinued JCP Men’s, Stafford Prep, JOE By Joseph Abboud, William Rast, Joe Fresh Kids, and J.C. Penney Company, Inc. (NYSE:JCP) Everyday brands – nearly all of the leftover product was moved to separate clearance sections. In sum, meaningful and noticeable changes have been made with stores harkening back to the pre-Johnson days – a favorable development in our view. See Figures 1-14 for pictures.

Key Take #4: Inventory Levels in Decent Shape. Despite +25% year-over-year inventory levels at FY13 end, we didn’t see many red flags in our checks. As expected, we did notice clearance activity (multiple Red Zone Clearance signs in store to complement 25% off sale on 3/11-3/12) for discontinued brands (as mentioned in Key Take #3 above) and those scaled back in Home, in addition to a fairly normal amount of clearance (30-70% discounts) in winter/fall merchandise across apparel categories. With that said, we did see a higher than normal proportion of national brands being cleared including Nike, Adidas, Levi’s, Carter’s and Dockers, we suspect in the aftermath of severe weather. In general, racks looked relatively clean and most inventory looked fresh and ready for the spring selling season.

Key Take #5: No Signs of Significant Store Level SG&A Cuts. Finally, we had been concerned that Penney’s near record low ~$1 billion core SG&A would impact the in-store experience through reduced service levels, poor maintenance, etc.; our recent visits helped ease our concerns. Specifically, we found the stores to be on par with our historical experience at J.C. Penney Company, Inc. (NYSE:JCP) with store personnel readily available to help, generally well-kept stores, and clean restrooms/fitting rooms. Of course, we do expect the SG&A per square foot to bounce off the FY13 $36-$37 lows, particularly if sales reach guided MSD targets, but our recent checks make us comfortable with our modeled assumption for modest growth going forward.

Maintain Neutral Rating & Sidelines Position. Shares of J.C. Penney Company, Inc. (NYSE:JCP) have enjoyed a very nice rally since the company reported EPS on February 26. With liquidity concerns on the back burner (for now), the focus has returned to fundamentals, which for the moment appear to be improving, albeit modestly. All told, while the aforementioned observations from our field work are directionally favorable, we remain sidelined on the stock and reiterate our Neutral rating.