Betting on J.C. Penney's Ron Johnson 1:36p ET

NEW YORK (MarketWatch) -- Imagine taking a yoga class at J.C. Penney Co., or ordering a coffee and sitting at a table equipped with an iPad while you wait for your friends to finish their shopping.

That's part of the vision painted by Chief Executive Ron Johnson on Friday as he outlined his plan to make the retailer ( JCP ) a "mall within a mall" -- a specialty department store outfitted with such in-store shops as Levi's, Liz Claiborne, and Martha Stewart and a central "town square" area where, say, kids could have their pictures taken with Santa during the holiday season. See related story on Penney's rival Sears: Is it a financial play or a retail turnaround?

A big part of that, initiated earlier this year, also involves doing away with J.C. Penney's traditional promotional strategy of using coupons and frequent percentage-off sales, in favor of focusing on an everyday pricing strategy.

Investors, for now, are giving Johnson and his vision the benefit of the doubt, sending the Plano, Texas-based retailer's shares up 4% on a day where the broader markets headed lower.

"J.C. Penney was well on its way to become a zombie retailer," said Newedge analyst Bill Dreher in an interview. "He's taking some proactive and meaningful steps on how to evolve into a more active-traffic retailer. It's a huge undertaking which has had, and will continue to have, some challenges.

"But it looks like with time, it really could begin to work."

Investors also chose to stomach the painful fact that Penney just posted a wider-than-expected second-quarter loss of $147 million, or 67 cents a share, compared with a profit of $14 million, or 7 cents, a year earlier, after same-store sales tumbled another disappointing 22%. The company also withdrew its full-year guidance.

"I'm completely convinced that our transformation is on track," Johnson told analysts and investors on Friday. "It is very clear that withdrawing from our promotional model to a more everyday model has been harder than we anticipated. But it doesn't change our conviction that the promotional model had run its course and that we have a far better path forward."

While the company's sales fell and gross margin narrowed more than expected, meaning it has less leverage in terms of expenses, Johnson gave some positive signs and said that Penney is fixing the pricing and marketing mistakes the company made in the first half that he said left shoppers confused about its new strategy.

He said marketing had focused too much on the company's brand image earlier this year, instead of better communicating about its products and new pricing strategy. Meanwhile, too much of its marketing budget was spent on television instead of on print advertising.

On Aug. 1, Penney did away with its so-called good, better and best pricing, introduced earlier this year to further simplify its pricing tiers and concentrate on just everyday low prices and clearance prices. On the marketing front, Johnson canceled a July catalog and pulled back on TV and other marketing to make its message more focused on products and prices.

The company is also pushing other kinds of marketing. For instance, in August, it introduced free haircuts for kids for the back-to-school period, an initiative Johnson said has helped to drive traffic.

The introduction of in-store shops, such as Levi's jeans in August, also has been encouraging. Average selling price on the brand up was up over $5 from last year, Johnson said.

"That's a testimony to how the new store format could work," Dreher said. A 25% increase is "massive. That's a pretty darn good sign."

Another encouraging signal also can be seen in the company's traffic in the first 10 days of the critical back-to-school season, which showed traffic declined much less than the first-half trend while sales were about 2% better than the spring trends.

'Execution story'

Penney also eased investor concerns about its cash-flow situation and promised it would end the year with more than $1 billion of cash on hand. Management also dismissed the notion that some of its vendors are losing confidence and pulling back on the company's in-store shop concepts.

"In the absence of information, there's a lot of misinformation," Johnson said. "Not a single [vendor] has backed off from" our in-store shop strategy.

For the quarter ended July 28, sales fell 23% to $3 billion, including the negative impact of the company's exit from its outlet business.

Online sales, in contrast to most other retailers, tumbled 33% to $220 million -- an area Johnson also promised to fix.

On an adjusted basis, the retailer said it lost 37 cents a share. Analysts surveyed by FactSet Research had, on average, been looking for a loss of 26 cents a share on sales of $3.2 billion.

Gross margin narrowed to 33.2% from 38.3% while selling, general and administrative expenses rose to 34.7% from 31.8%.

With that performance, how long investors will keep their patience remains an open question.

"This is an execution story," said Hedgeye analyst Brian McGough in a note. "Execution requires trust. Trust needs to be earned. [Johnson's] team has zero."