New CEO Ron Johnson has a monumental challenge staring him in the face at J.C. Penney (JCP – $33.05). The problem is that it’s going to get much worse before it gets any better.
(Click here to view TRG’s latest research note on JCP)

Departing CEO Mike Ullman should have been replaced much sooner. A glance at the below trailing 4-quarter EBIT margin rates for both JCP and M highlight the relatively miserable financial performance JCP delivered under Mr. Ullman’s watch, especially the past 2-3 years. Note: JCP’s numbers excluding lower Pension Expense over the past 6 quarters would look even worse than what is depicted below.

Mr. Ullman’s ridiculous suggestion on the Q2 2011 conference call that its “identified growth initiatives” are performing double digits ahead of last year should be investigated by the SEC. This statement by an outgoing CEO is an affront to the company’s investors and a black eye to Mr. Ullman as he prepares to leave the company.

JCP Q2 2011 Conference Call – August 12, 2011 – CEO Mike Ullman

“Our identified growth initiatives – Liz Claiborne, Sephora Inside J.C. Penney, our tops business, modern shoes and handbags, fast fashion, Modern Bride, fine jewelry, housewares, and center core – are performing double-digit ahead of last year.”

JCP management can talk about improving the “center core” of the store and its various “growth initiatives” all they want. But, the company’s comp store sales results in the past 3-4 years have come up well short of its peer group.

We’re well below the consensus in Q4 2011 as 2-year profitability comparisons materially toughen. In the long run, incoming CEO Ron Johnson may be able to provide a needed spark to get this ship moving in the right direction. Let’s face it, the proverbial ‘bar’ has been set extremely low by his predecessor.

But, it’s going to get much uglier before investors begin to see tangible signs of hope. How plans on delivering EPS north of $1.60 next year is beyond us ($2.04 current consensus estimate).

Occasionally, TRG will post a relatively current research note on Retail Geeks. Here’s a recent note we published on AAPL ahead of the company’s earnings release on Tuesday afternoon.

Apple (AAPL – $357.77) will again easily exceed the consensus sell-side EPS expectation in Q3 2010 (June 2011). In our view, GPM% upside versus consensus expectations appears to be the largest driver of material EPS outperformance versus today’s consensus sell-side estimates.

Why? GPM% pressures ease in Q3 2010 (June 2011) as the company has now fully lapped its iPad launch (i.e. sales mix is much less of an issue this quarter than the prior 4 quarters). iPad revenues are likely to double in Q3 versus LY, but so will the higher margin iPhones.

Also, keep an eye on Product Warranty Accruals. Per SEC filings, AAPL’s Product Warranty Accruals (see table below) have greatly out-stripped the actual Product Warranty Costs for the past 3 fiscal quarters. AAPL may receive a GPM% boost beginning in Q4 (if not earlier) if Product Warranty Accruals are scaled-back versus the prior year.

While GPM% should be much stronger than consensus expectations, we’re concerned about the top-line. There was no iPhone launch in June 2011 to lap last year’s launch of iPhone 4. Therefore, Q4 (September 2011) will not receive a material top-line boost via a product launch this year as it did last year.

In Q3 2010 (June 2011), we’re forecasting EPS of $6.29 versus the current consensus sell-side estimate of $5.80. Our estimate implies revenue growth of +59.3%, a +175 Bps GPM% versus LY, and a +395 Bps EBIT margin improvement versus LY.

In Q4 2010 (Sept 2011), we’re forecasting EPS of $6.84 versus the current consensus sell-side estimate of $6.42. Our estimate implies revenue growth of +32.8%, a +375 Bps GPM% versus LY, and a +451 Bps EBIT margin improvement versus LY.

See link for the full research note and an updated EPS model and company Data Packet.

Talbots (TLB – $2.53) reported another in a string of disappointing earnings results this week. Nothing new here. Over a year ago, we suggested that we thought TLB’s BPW acquisition was a disaster waiting to happen.

But, the company’s quarterly earnings conference call this week provided yet another example of the company addressing relatively short-term concerns and ignoring a bigger issue… the company’s bloated average store size.

First, let’s take a look at a few of CEO Trudy Sullivan’s ridiculous comments from this week’s conference call:

Apparently, Ms. Sullivan may not have actually looked at the financial results for Q1 2011 and the company’s guidance for Q2 2011. These sort of Mr. Magoo-like comments from her just make you scratch your head.

As if that was not enough spin doctoring above, Ms. Sullivan finally suggested on the conference call that, “I feel very, very optimistic about the corrections we have made to the product as we ramp into the back half.”

Therein lies the problem. Ms. Sullivan and TLB have a long track record of promising improved performance in the future. Yet, it never seems to appear.

The stock price today is a far cry from the $13.00+ per share level that was seen just prior to the acquisition of BPW (a SPAC) over a year ago. How this management team remains employed is beyond us.

In our view, the unveiling of a Three-Year Strategic Plan (October 2010) was nothing more than an attempt to “buy time” to stay employed for the next 12-24 months before investors recognized that the emperor had no clothes (literally). How Ms. Sullivan remains employed today is beyond us.

So, when Ms. Sullivan is finally shown the door, how can TLB be salvaged?

The elephant in the room is the company’s bloated store size. There is a reason that CHS has historically delivered much stronger levels of profitability than TLB and CWTR (good grief, another CEO that needs to exit stage left). CHS has an average store size that is less than half the size of TLB/CWTR.

The fact is that TLB’s store size (7,000+ square feet) worked well 10-15 years ago when there was less competition.

TLB management needs to think bigger than simply fixing the knit/sweater categories (apparently, the only problem today according to TLB management). Closing stores is a step in the right direction, but right-sizing the core chain’s square footage is a strategic thought process that is being missed by the current management team.

Why is TLB management not addressing the most important issue facing the core chain today (square footage rationalization)? Unfortunately, TLB management is trying to fix a “new age” problem with “old school” thinking.

Clearly, TLB management believes that a tweak to the product will turn things around (i.e. old school). But, the company will need to think bigger and address its real estate conundrum if the company wants to remain a viable entity in the years ahead. Otherwise, Ms. Sullivan’s “small” thinking is likely to produce a “big” flirtation with Chapter 11.

In fairness, Ms. Sullivan is faced with a dilemma that many CEOs in retail are grappling with today. Most retail CEOs are trying to continue selling a growth story to investors. But, many of these CEOs are putting the long-term viability of their companies in jeopardy by not addressing the “bigger” issues of the day.

Certainly, it’s less ‘sexy’ to tell the investment community that you’re embarking on a program to lower your average store size and rationalizing square footage by -25%. But, in the Internet age, many of these chains should be more focused on their web site and less focused on maintaining a chain’s historical box size.

Ms. Sullivan’s seeming desire to consistently satisfy the short-term investment community (quarterly spin doctoring) is getting in the way of addressing a longer-term problem for the core chain. If she (or, the next CEO) does not start to address what really ails the company (bloated square footage), she’ll continue to put the future of the company in jeopardy.

During the bevy of retail sector earnings releases over the past few weeks, we’ve all heard many retailers complain about the weather negatively impacting sales in Q1 2011. Yet, most of these same retailers suggested that top-line trends had materially improved in the first 2-3 weeks of May 2011.

Here’s where it gets interesting. Many retailers disclosed in their May 2010 sales reports that sales were depressed in the first half of fiscal May 2010 and greatly improved in the second half of the fiscal month upon the arrival of more seasonal weather. Here are some examples:

Also, comp store sales a year ago were artificially depressed via a Memorial Day fiscal calendar shift (i.e. the Sunday/Monday of Memorial Day weekend shifted from fiscal May in FY 2009 to fiscal June in FY 2010).

Did many retailers get a “false positive” top-line read in the first half of fiscal May 2011 as they lapped last year’s dismal weather? Did artificially boosted comp store sales in the first half of fiscal May 2011 inflate top-line expectations for Q2 2011? Are sell-side analysts looking at artificially depressed comp store sales from a year ago and thinking that comparisons will be easy to anniversary (via Memorial Day calendar shift in May 2010 versus May 2009)?

We all know that sales were strong in early-May 2011. But, what about the sales trend in the second half of the month?

If sell-side analysts are basing their May 2011 comp store sales projections on managerial commentary in mid-May, the month’s sales results could disappoint investors this week.

Yesterday, Collective Brands (PSS – $15.07) hit a grand slam. All four operating divisions delivered materially lower levels of profitability in Q1 2011 versus LY. Certainly, not the type of grand slam that investors in the company wanted to see.

An objective analysis of the numbers would suggest that PSS’s CEO has delivered nothing since his arrival in FY 2005. But, he spends much of the conference call attempting to describe the relatively immaterial ‘wins’ that he has been responsible for.

We get it. Most management teams attempt to spin information as positively as they can to mask the deficiencies in their performance. But, Mr. Rubel of PSS takes it to a new level. He’s known to spend extraordinary amounts of time in his conference calls discussing the success he’s having with a variety of immaterial aspects of the business (e.g. how material is the success of the Latin American business or the Sperry retail store roll-out?).

But, here’s our favorite quote attributed to Mr. Rubel during this week’s conference call::

In our view, that’s the interesting part. Mr. Rubel appears to be so delusional that he believes “everything else” is working.

So, let’s ignore abysmal results at Payless Domestic for a moment. Payless Canada is not working. Despite strong sales growth, PLG Wholesale EBIT margins are in decline (Q4 2010/Q1 2011). Stride Rite retail continues to report comp store sales declines.

Inventory growth has exceeded sales growth 4 straight quarters, yet investors are supposed to believe that aged inventory is not a concern. PSS management provided the standard excuses that are designed to allay any fears that inventory levels are bloated.

Yep, everything else is working.

Finally, the elephant in the room is WMT, KSS, Forever 21, ROST, and TJX. Collectively, they’re KILLING Payless Domestic. We’re surprised that no one asked Mr. Ruble about the impact that WMT is having on PSS as they add-back to their shoe assortment (see WMT’s Q4 2010 conference call).

Here’s how we think that this plays out. PSS faces materially easier 2-year comp sales and profitability run rates in Q2 2011 versus Q1 2011. Therefore, Q2 2011 profitability performance will sequentially improve versus Q1 2011 (i.e. less year-over-year EBIT margin degradation). But, the dramatically tougher profitability comparisons that the company faces in Q3/Q4 2011 will be difficult to anniversary.

There may be additional “grand slams” in PSS’s future beginning in 2H 2011 (click here to see our updated company Data Packet).