In my portfolio review to start 2013 (here), I said the following about J.C. Penney (JCP):
“I’ve written about J.C. Penney extensively, and my interest in the company shouldn’t come as any surprise to regular readers. I used the recent pullback in the stock to average down (yet left myself with no cash when the stock got really attractive – a mistake that I’ve made previously and am hoping to learn from one day) and have a cost basis in line with the current price. The biggest update as of late has been a clear increase in the amount of discounting at the retailer, a change that should provide for some interesting commentary on the upcoming conference call (namely, if the pricing transformation was required to attract top-tier brands, will they still be interested in coming to JCP after the recent spate of clearance activity). I still see an attractive balance of risk and reward – from my view, there’s limited downside even if the strategy fails (management’s willingness to adjust is KEY), yet material upside (2 to 3x) in 24 to 36 months if the transformation plays out as anticipated.”
As I noted, there’s a lingering question running through my head: If the pricing strategy adopted was necessary to attract top-tier brands, will those brands still be interested in coming to JCP after the recent spate of promotional activity? As an extension, is this promotional strategy a fleeting occurrence, or will they once again become part of the business? I thought I would need to wait for the fourth quarter conference call to get any new word on either front. However, a recent interview with Bill Ackman from CNN Money (here) addressed my second question; towards the tail end of the video, Ackman says the following:
“It’s amazing how short-term the market is. When we hired him, the stock went from $30 to $36; when he announced his plan, it went to $43 – that was February of last year. He said sales would be down, because when you withdraw all that promotion and get rid of all the sales, and by the way he’s bringing sales back – that’s, of course, what I think is going to help drive sales. You’re going to see more sales; you won’t see 500, but you’re going to see a sale on Mother’s Day, you’re going to see a sale on Valentine’s Day.”
As I noted in my portfolio review, I believe that management’s ability to adjust is absolutely key to this transformation. Along the way, many have assumed that Johnson would stick with his plan 100%, no matter what (assuming the company could afford it), regardless of the pain; from what Ackman says (and based on recent promotional activity in the stores), it sounds like Johnson is willing to adjust as the numbers tell him to do so.
In regard to my original question, it’s unclear how J.C. Penney’s branded suppliers (namely those not yet on board) will feel about the company’s earlier proclamations while simultaneously straddling a more promotional strategy (granted, at a level meaningful below that of years past). To be clear, I think this is critically important: Differentiation is a must, and a strategy of selling commodity-type products (unbranded towels and toasters, for example) through a game of inflated retail prices and endless markdowns is a loser in a world of ecommerce (driving price competition) and increasing price transparency (largely due to smartphone penetration).
I agree with Ackman – the market is obsessively fixated on short-term results. Here’s a quote from my original JCP submission about Johnson (to provide some historical perspective about the man who many likely consider a retail failure, if they listen to the financial media):
“Ron Johnson was born in Minnesota in 1959, and was the son of an executive at General Mills and a nurse turned homemaker. He received a degree in economics from Stanford University, and after a short stint as an accountant, received an MBA from Harvard Business School in 1984. As retold in a recent Fortune interview, Johnson turned down offers from places like Salomon Brothers and Goldman Sachs to work at Mervyn’s, a middle scale department store chain that was owned by Dayton Hudson (the present day Target) - 'I thought, I want to be really good at something…I want to run a company one day, and I need to learn the business from the ground up.'
Six years later, Johnson was moved to Target (Mervyn’s was run as a separate subsidiary) and was put in charge of housewares; his prominence began to rise after he hired architect Michael Graves to create low-cost versions of his designer products (140 of them). As noted in the Fortune article, the impact was sizable, practically redefining the Target brand as a 'chic discounter' – 'The Graves line was such a smash that Target's image changed from a ho-hum discounter to a store that sells stylish but affordable products.' It’s important to recognize that the transformation at Target was similar to what Johnson is implementing today – he ran the Home area for Target from 1995 to 2000; over that period, the number of products sold that were on sale dropped from 40% to 3%.
In 1999, his career took a change in direction. A recruiter invited him to meet with Steve Jobs about building the retail operation for Apple (NASDAQ:AAPL). Jobs asked headhunters to bring him the best retailer they could find – with Johnson’s name topping the list. At the time, Apple was just a few years past a near collapse (Microsoft invested $150 million in the company in a move many experts called an antitrust insurance policy), but Johnson left Target and accepted Jobs' offer: “I wanted to help him fulfill his dream, which was to change people’s lives.” Johnson was the architect behind store designs and the Genius Bar, taking Apple retail from infancy to $18 billion in sales. Today, Apple stores average roughly $6,000 of sales per square foot.
When Johnson decided to come to JCP, he made a financial commitment that aligned his long-term interests with shareholders: He invested $50 million in warrants at market value with a seven-and-a-half-year maturity period (and he can’t hedge/sell for six years) – meaning that if JCP is trading at or below $29.92 in 2017, he loses every last penny.
Over the past 12 months, Johnson has surrounded himself with a balance of 41 former colleagues and legacy JCP employees, bringing with them experience as executives from places like Abercrombie & Fitch, GE, Apple, Gap, Boeing, Nike, Disney, Home Depot, and PepsiCo.”
In 2011, more than 70% of J.C. Penney’s revenue came from products sold at a discount of 50% or more; just 0.2% of the company’s sales came from products sold at the sticker price. It’s all but certain that the “no sale” talk is done at Penney’s – but we’re not going back to 2011 either.
If you look at the store designs and the early “new JCP” results, the shops (and eventually the overall store layout) have changed the game for the company and are core to the ongoing transformation; continuously adapting and learning from failure – in this instance, on the pricing front – is the only way to proceed (like a start-up). With a valuation that questions JCP as a going concern (and in my opinion disregards the early shop data), I continue to believe that investors will look back in two to three years and wish they’d purchased JCP at current levels.
About the author:
I think Charlie Munger has the right idea: "Patience followed by pretty aggressive conduct."
I run a fairly concentrated portfolio, with a handful of positions accounting for the majority of the total. From the perspective of a businessman, I believe this is sufficient diversification.