J C Penney Company Inc Gross Margin Recovery is Crucial: Morgan Stanley

Analysts at Morgan Stanley were encouraged by the progress of J C Penney in the second quarter and noted the company’s sales momentum and tight management of its SG&A expenses. They also emphasized that its gross margin recovery is crucial.

According to Morgan Stanley analysts Kimberly Greenberger, Lauren Cassel and Gregory Baglione, J C Penney posted a 4.1%increase in comparable store sales, which exceeded their 3.5% estimate and the Street’s 4%.

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J C Penney has momentum towards second half of 2015

The analysts also said, “We were impressed bu the 330 bps decline in SG&A (vs. our 33.4% estimate), which drove most of the beat in this quarter’s $(0.45) loss (vs. our $0.48 loss and Street’s $0.50 loss).”

Greenberger and fellow analysts believe that J C Penney has a momentum toward the second half of 2015 with positive trends in top-line metrics including transactions, conversion, AUR and 87 million active customers.

J C Penney needs to sustain gross margin recovery

According to the analysts, gross margin recovery is a crucial step for J C Penney to achieve an EBITDA of $1.2 billion by 2017.

Greenberg and her colleagues estimated that J C Penney will achieve a 36% gross margin this year, an increase of ~400 to 500 bps from 2012. According to them, the company regained ~540 bps of margin LY primarily on improved merchandise margins). J C Penney achieved a 220 bps improvement in the first half of 2015.

The analysts noted that the management of J C Penney issued a more conservative outlook for the second half of this year (~70 to 100 bps gross margin improvement). According to them, the company may signal further improvement in 2016 and the following years will be less robust.

J C Penney signals omnichannel focus with new hires

Furthermore, the analysts noted that J C Penney signaled that it is focused on omnichannel with its newly hired executives that could drive CapEx above its current estimate. They also suggested that its leadership changes in infrastructure/technology probably also indicated the need for re-directing or increasing investments.

J C Penney hired Michael Amend, the former vice president of Online, Mobile and Omnichannel ar Home Depot and Micke Robbins, the former senior vice president of Global Supply Chain at Target.

“We are in favor of JCP’s desire to lead in omnichannel retailing, but given the heightened focus by peers (FY15 CapEx for KSS/M ~800M/$1.2B in 2015), we think it may be difficult to stay competitive while underinvesting,” according to the analysts.