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Can J.C. Penney Weather a Market Downturn?

At times it's seemed like J.C Penney (NYSE: JCP) would be a retail winner. The chain has made a number of strong moves, including adding appliances, offering home services in markets abandoned by Sears (NASDAQ: SHLD), and improving its in-store salons.

The problem is those efforts only partly succeeded. J.C. Penney has identified areas where it can succeed, including appliances and certain types of women's apparel, but it has also made some missteps. These forced the company to liquidate some inventory in Q3. That's actually good for comparable-store sales, which it expects to come in at 0.6% to 0.8%, but it's bad for profits, which will come in at a loss between $0.40 and $0.45 a a share.

The problem for J.C. Penney is that its path to finding a working business model has not been straight. That leaves the company, which predicts a mild profit between $0.02 and $0.08 a share, vulnerable to a market downturn.

If retail conditions for brick-and-mortar chains deteriorate this holiday season, that could send J.C Penney to a loss. If that happens, vendors and customers may lose faith in the chain, which could cause the kind of negative domino effect that Sears has been struggling with.

J.C. Penney is at a vulnerable point in its recovery. Image source: J.C. Penney.

What's happening with J.C. Penney?

Some aspects of its turnaround plan have been working. Adding appliances to more than half its stores has been a success. In addition, the company has found that it was offering too much of what it has called traditional women's clothing, while more casual clothing has been selling better. CEO Marvin Ellison explained how the company was adjusting to what it has learned in a press release.

Based on the encouraging results from a third quarter reset in women's apparel, which expanded our casual and contemporary offering, we made the strategic decision to accelerate a wider transformation of the entire women's department by clearing slow-moving inventory primarily in women's and other apparel categories. Following this comprehensive reset, we saw an improvement in performance, particularly in our women's division, confirming these actions were necessary to drive growth in our women's apparel business.

In a normal market this would be good news. J.C. Penney has found a product mix that appears to work better than the one it had used in the past. The problem facing the company is that the entire traditional retail space has been declining, and if that speeds up in Q4 it could undermine the overall strategy.

Perception is reality

While Sears has struggled for years, it actually has assets remaining to sell. That means it has the ability to generate cash to pay vendors even if sales remain a problem. Unfortunately, at least for the company, vendors have seen the declining sales narrative, and some have refused to ship to the chain without advance payment.

Sears has fought that by taking loans from hedge funds controlled by its CEO Edward Lampert. That will work for a while, but if vendors and customers start to believe that bankruptcy is inevitable, they will neither ship to the chain not shop there.

J.C. Penney faces a similar problem. It's pointed in the right direction, but its survival and success are certainly not assured. A bad holiday season, due not just to the chain's struggles but also a market downturn for brick-and-mortar chains, puts its survival at risk.

This is a critical period for the struggling department store. If it can show even some slight positives -- a profit for the year and flat comparable-store sales would be a major win -- then investors may relax. In addition, vendors will exhale and give the company more runway to complete its transformation.

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Daniel B. Kline has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.