J C Penney Company Inc (NYSE:JCP) released its latest earnings report last night, surprising Wall Street with losses that weren’t as bad as expected. Analysts at Sterne Agee say the department store chain is taking the steps necessary to “right the ship.” However, they remain Neutral-rated on the company because in the end, the earnings report delivered mixed news.

J C Penney makes progress

In a report dated Aug. 14, 2014, analysts Charles Grom, Renato Basanta and John Parke note that J C Penney was expected to show top-line momentum. However, the company surprised by significantly improving gross margins and also reporting “very tight” selling, general, and administrative expenses and inventory levels.

J C Penney posted adjusted losses of 73 cents, compared to their estimate of a $1 per share loss. Reported losses were 56 cents a share due to several one-time gains. The Sterne Agee team said the better-than-expected gross margin of 36% and lower selling, general, and administrative expenses drove the beat.

The analysts note that the retail chain’s annual sales remain $6 billion under peak levels, which means the turnaround process is still in the early stages. As a result, they say the execution risk is still high. On the net side, they say the fourth quarter will be a key indicator of whether J C Penney is making progress because the comparison bar gets more difficult. Until they see the fourth quarter results, however, they’re staying on the sidelines.

5 good things about J C Penney’s earnings

The Sterne Agee points out five bits of good news in the department store chain’s earnings report. First, the 6% improvement in comparable sales was better than their expectation of a 5% improvement.  In the last week of the quarter, J C Penney saw double-digit comparables and encouraging trends so far in the current quarter.

Second, the company saw a 640 basis point increase in gross margins, mostly due to better margins on clearance items, a lower clearance mix of less than 15%, and higher penetration of private brands. Third, the retail chain’s inventories fell 9.7%, compared to the 5% sales growth. Fourth, J C Penney kept its selling, general and administrative expenses “at very lean levels,” bringing them down 6%. And finally, the company kept its MSD comparable target the same but increased free cash flow guidance from break even to positive.

Bad things about J C Penney’s results

On the other hand, there were a few bad things, according to the Sterne Agee team. They note that traffic was still negative in the quarter even though there was a better comparable sales number. As a result, they say it looks like the progress is slow, particularly when thinking about the last two years’ big declines of more than 30%.

In addition, they think that nearly 200 basis points of J C Penney Company Inc (NYSE:JCP)’s comparable sales gain was because of the 25% increase in home stores cycling up from their closings last year. Also they wonder whether the retail chain’s “super-lean inventory levels” will be high enough to support the company’s positive top-line momentum.

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