Premature Price Target Upgrade on JCP Shares?

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Premature Price Target Upgrade on JCP Shares?

By Richard Robinson, Ph.D., Equities Analyst

Wells Fargo (WFC) recently conducted a study examining how a retail company’s earnings estimates affected its stock price.

Out of the 51 retail businesses in the sample, the study showed that earnings estimates declined on a year-over-year basis for 42 of them.

Now, given the adage that stock prices follow earnings, researchers expected to see a decline in stock prices proportionate to the earnings dips.

Instead, something strange and twisted happened…

Only 13 of the 42 companies with lower earnings estimates (or 31%) actually experienced a lower stock price.

The takeaway?

Investors appear to give retailers the benefit of the doubt when it comes to falling earnings estimates.

And that, in part, may help explain why Piper Jaffray raised its price target to $14 on the department store retailer, J.C. Penney (JCP), despite the company’s still-troubling earnings outlook.

It would seem the impetus behind the higher target were comparable store results coming in at 3%, three times higher than previous projections of just 1%.

Analysts indicated that the increased sales were likely the result of better weather this year compared to last year.

In addition to the weather hypothesis, some are hoping that Apple’s (AAPL) soon-to-be released watch will result in increased mall traffic, therefore benefiting retailers like J.C. Penney and its beleaguered stock.

In response to Jaffray’s upgrade, JCP shares spiked more than 7.4% on Tuesday. The news also brings renewed hope to JCP shareholders that the company is finally turning a corner.

Less Hoping, More Doing

Unfortunately, the troubles at J.C. Penney go much too deep to be solved by a relatively minor increase in comparable store sales and increases in mall traffic.

Earlier efforts proved successful for getting customers back into the stores, but they weren’t spending.

You see, J.C. Penney sales in 2007 totaled $18.6 billion from 64 million active customers (or $290.62 per active customer).

By 2013, the company had sales of just $11.9 billion from an estimated 77 million active customers – which is a significant decline to just $154.54 per active customer.

Just last year, the retailer made additional efforts to increase customer volume. And it worked; the company saw its customer base return to its 2011 numbers of 87 million active customers.

But the larger problem remained intact . . .

J.C. Penney’s 87 million customers spent only $12.3 billion – or $141.37 per customer. (Ouch!)

It’s the same story, different day: While the company has proven that it can increase customer volume, it hasn’t yet figured out how to get them to cough up the bucks.

And it’s a metric the company must resolve if it wants to remain relevant.

A Premature Call

J.C. Penney is still a long way from solving the customer spending problem. And while Jaffray’s upgrade gave the markets something to talk about, the gains will likely be short-lived.

The company must innovate in order to avoid the kind of irrelevancy that Kmart experienced two decades ago. But with more than $5.4 billion of debt on the books, it can’t really afford it – leaving it with very few options.

Investors would do well to remember that stock prices generally follow earnings. And until J.C. Penney’s earnings improve, the company is surviving on (false) hope.

Good investing,

Richard Robinson

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By Richard Robinson