Bill Ackman’s Activist Positions in J.C. Penney and Canadian Pacific Railway
Once a retailer of bland, low-priced fashions and house wares, J.C. Penney (JCP) got a jolt when Ackman acquired over 17 percent of it in 2010 to 2011 and vowed to effect a “transformation” that would deliver outsized returns. This week, Ackman’s letter containing his explanation of his steps at J.C. Penney coincided with the stock’s dip to its 52-week low on lower sales. Ackman’s success with JCP seems to hinge on whether customers will return to its new and improved version after the transition period, now in its early stages.
Prior to Ackman’s entrance, J.C. Penney’s model was becoming outdated and its top line began to slide: Revenues dipped from $19.9 billion in 2007 to $17.6 billion in 2010. In 2010, the company’s comparable same store sales and total net sales actually grew modestly, as several changes were already underway.
For instance, J.C. Penney had opened 76 Sephora stores within stores and launched the Liz Claiborne brand. In the first quarter of 2012, JCP opened 17 Sephoras inside JCP stores, bringing the total to 325 locations and two new department stores. It also discontinued its catalog print media and closed down its catalog outlet stores that year.
Ackman wants to attract other vendors to JCP through its revamped brand and cheaper rents and openings costs.
“By building out new shops which generate substantially higher sales per square foot, JCP should be able to greatly increase its overall sales per square foot and profitability,” Ackman said in his letter.
The biggest problem has been with the company’s promotional strategy, though. Ackman and JCP also did away with the company’s numerous discounts. Instead, they rolled out a “Fair and Square” pricing strategy that divided pricing into three types: everyday, month-long and best or lowest prices.
The problem with the pricing strategy is that the meaning is not self-evident. In fact, lack of success educating consumers about it led to an 18.9 percent decline in sales in the first quarter. Then, the company was forced to make deeper markdowns to move accumulated seasonal inventory.
If the company does a better job familiarizing consumers with the pricing plan, sales could pick up in the second quarter, making the stock’s price dip temporary. But if management does not acknowledge the mistake, it could prolong the stock price depression. Ackman addressed the issue in his letter, saying, “Ron and the rest of the JCP team are working hard to fix the marketing and messaging, and we are confident that they will get it right.”
Thus far, Ackman’s efforts to raise the quality of merchandise and streamline the store’s discount strategy has driven some customers from the stores. Yet he believes that when the transformation is complete, the store will appeal to more customers than before.
His vision for the store (as he compares it to a mall in his letter) is: “With time and some changes, the marketing message for the property will be better understood, old customers who left will return, and a large base of new customers, who hadn’t shopped at the property before, will start shopping because they are attracted by the new tenants and the more attractive and compelling shopping experience. The mall will become the most attractive place to shop in the market because each month two to three new stores will be opening which will create news and a reason for existing and new customers to shop in the mall.”
Whether or not sales return and affirm the long-term profitability of a JCP investment, even Ackman expects more volatility in the stock in the near term.
Control of Canadian Pacific Railway (CP), the second-largest railway in Canada, is now in Ackman’s hands. As he says in his letter, the vast majority of shareholders welcomed he and his six board nominees in May, while the chairman and CEO received the fewest votes and resigned.
Ackman’s task is to turn around a company whose revenues and earnings have grown little in recent years. Revenue was $4.4 billion in 2005 and $4.8 billion in 2010. Earnings over that period went from $448 million to $563 million. Free cash flow fell to a loss in 2010 and 2011.The company lags the industry in several measures. For instance, it has a net margin of 12.6 percent, lower than the industry’s 16 percent; ROE TTM is 13.9 percent compared to 17.2 percent; and debt to equity is 1.0 compared to 0.8.
Ackman believes almost all of the railroad’s issues are related to operations. The operating ratio – the company’s operating expenses as a percentage of revenue – is a key measurement for a railway’s efficiency. Canadian Pacific had been working toward the goal of lowering its operating ratio to between 70 and 72 percent by 2014. Canadian National (CNI), its closest competitor, has already decreased its operating ratio to 63.5 percent in 2011. Of all large railroads, only Canadian Pacific failed to improve its operating ratio materially since 2003, according to Morningstar.
The more efficient Canadian National trades for $80.81 a share on Thursday, compared to $70.97 for Canadian Pacific. If Ackman’s new board can similarly streamline the company, investors stand to realize substantial upside. It may prove difficult to do, as workers at CP have gone on strike recently after cost-cutting measures included reducing post-retirement benefits by 40 percent.
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