Free 7-day Trial
All Articles and Columns »

JCP - Year End 2012

March 02, 2013 | About:
The Science of Hitting

The Science of Hitting

216 followers
JCPenney (JCP) reported fourth quarter earnings after the close on Wednesday, and it’s safe to say that management and investors are happy to see 2012 is finally complete. For the full year, sales declined by nearly one-quarter (even when including a 53rd week) to just shy of $13 billion; we’ll take a closer look at the income statement in a second, but it’s safe to say that the financials were utterly atrocious. As we can see (here), Bill Ackman’s original expectation – that sales would start to turn positive by August 2012 with the addition of the first shops – clearly doesn’t mesh with today’s reality; in fact, comps worsened throughout 2012.

Management’s pricing strategy, one that I fully supported in hope of better customer service (less time spent changing signage) and in fear of increased price transparency due to Smartphones, has been disappointing; this year was largely a test of that strategy – and resulted in demonstrable damage to the company’s financial position heading into 2013.

With that said, let me be clear about something: the real target, in my view, is differentiation in the store. Partnering with brands like Joe Fresh, Disney, Michael Graves, and others, was always the goal; the pricing strategy was, in a lot of ways (at least as told by management), the only way to appeal to – and land – these brand-conscious suppliers. Despite management’s decision to revert to a more promotional model, there’s no indication that any national brand partners have an interest in backing out of their shop plans with JCP; the company’s pricing strategy targets promotion in JCP’s own private label brands (“going to promote them more aggressively to get customers in the store”), with national brand partners able to run their business as they see fit.

HOME: AN UNMITIGATED DISASTER

The company’s troubles for the year were most apparent in the home department. As I noted in an article from last October (“JCP – A Consumer Perspective”), it really didn’t seem like it could have been otherwise:

“Once I got out of the apparel sections and into the areas selling kitchen appliances and home goods, I noticed that a lot of the products being sold didn’t really mesh with what I envision as the future of JCP. A great example of this was a rack of 50 to 100 boxes of K-cups and Nespresso pods. I simply cannot imagine who comes to JCPenney to load up capsules for their single-serve coffee machine (and after looking at the rapidly approaching expiration date on many of the boxes, the answer might be that not many people do). Thinking about the strategy as presented by Johnson, it is about product quality, with a focus on differentiated experiences and offerings. What the company will do in sections like kitchen to eliminate the plethora of cheap appliances and other trinkets that have no real place in the store and face direct competition with the Walmart’s (WMT) and Amazon’s (AMZN) of the world is still a bit unclear to me.”

On the Q4 call, management provided some commentary that perfectly encapsulates the problem facing the company in home – a problem that will hopefully turn and start heading in the right direction in the coming months (emphasis added):

"But the biggest change of all is coming in May. As you know, we are undertaking a complete makeover of our home department with an average of 19,000 square feet per store under construction as we speak. Home has been one of the worst performing categories in our stores for years and in particular this past year and we’re going to get the business back. Home formerly ran nearly 20% of J. C. Penney store sales and over the years it has declined to a mere 10%. Sales per square foot in home which formerly ran at $185 per foot have dropped through the years to under $80 per square foot. It’s an incredible opportunity and a great place to launch the new JCP.

When we unveil our new home department in May, we will have created the most exciting place to buy home products in America. With new partners such as Martha Stewart, Michael Graves, Jonathan Adler, Sir Terence Conran and more and great brands such as Bodum and Calphalon, and OXO and Keurig, we will have the most sought after products for Americans to update their homes and we will introduce a shopping environment unlike any other. We will roll out nearly 20 new shops, create a street in our stores filled with activities and some stores will even include a kitchen where people can learn and get help.”

Even if the company is able to include products from Martha Stewart in the coming months (far from certain), I’m still questionable about this business (I’ll believe it when I see it); considering that home accounts for more than 10% of the average square feet in JCP’s on-mall locations (19,000/145,000), success here is vital. The one thing going for this section of the store is the atrocious comparison – by my back of the envelope math, pulling same store sales to even $125-130 per square foot would add about $800 million – or +6% - to JCP’s top line results in 2013.

Success in home is also critical because it will result in material CapEx for JCP, and will need to partially fund continued expansion through the end of 2013; as noted on the call, continued additions will transition the stores from a handful of shops towards increased saturation: “When home is completed in May, we will have transformed over 30% of the floor space in over 500 stores and we’ll move from having a few islands of improved space to critical mass and we expect this to provide synergy between the new JCP and J.C. Penney. As customers come in to shop for home, they’ll discover Joe Fresh and Sephora and MNG by Mango and more and many will see for the first time the irresistible style and unmatched value we deliver through our great own brands such as Arizona, Liz Claiborne, Worthington, JCP and St. John's Bay.”

YEAR END FINANCES

Looking at the financials, let’s start by counting the cash; starting with the cash flow statement, we see cash flow from operations was a use of $10 million for the year. This number was materially improved by +$748 million from working capital, a result that will not recur in the coming fiscal year. The net decrease in cash for the year was $577 million, with notable items being repayment of long term debt (use of $230M), CapEx (use of $810M, up from $634M in the prior fiscal year), a decrease in inventory and an increase in payables (collectively, +$715M), $526M from the proceeds on the sale of non-core assets, and finally a GAAP loss of $985M.

On the balance sheet, the company ended the year with $930 million in cash, and $845 million after adjusting for the deferral of select vendor payments in the fourth quarter – well below management’s target of $1 billion at year end; this is a target that I had a clear eye on, and a big miss in my book (should’ve been guiding very conservatively considering timing of estimate). Of course, cash isn’t the only asset we’re counting; as pointed out by CFO Ken Hannah during the call, “other assets” were a significant area of monetization for JCP in 2012, and they see continued opportunities in 2013: “All other assets are down $422M for the year. This was primarily driven by the monetization of the non-core assets early in the year for our REIT ownership interest, leverage leases, and regional mall partnerships. We still have several hundred million dollars of opportunity here.” The “other assets” account on the balance sheet was reported at $745 million as of February 2nd, 2013, yet rarely receives a single line in articles proclaiming cash troubles at JCP; I’ll discuss this key account further when we get the 10-K.

Another important item to touch on is the company’s credit facility, which was amended a few weeks ago; here again is Mr. Hannah, explaining the updated facility terms: “We increased the line of credit from $1.5 billion to $1.85 billion and increased the number of lenders. We also increased the accordion feature from $250 million to $400 million. We increased the flexibility for third-party financing and updated the representations and warranty section to acknowledge the business results in the first year of our transformation. There were no changes to the asset borrowing base, which were the company's receivables and inventories, nor the borrowing rates. There are no new financial covenants associated with this facility. We are very pleased with the support of our banking partners.”

If we look at the line of credit, including the accordion feature, in combination with the roughly $850M in cash on the books (adjusted for deferred vendor payment early in Q1), JCP has access to about $3 billion in short term capital. Thinking about this balance in addition to other assets and potential transactions with company-owned real estate (as noted in Section 6.06 of the credit agreement, the company is allowed to engage in Sale/Leaseback transactions if certain criteria are met), I still believe that financials will support shop construction throughout the full year, with much help from continued asset monetization (if we don’t see material sales per square foot improvements in departments like home, a lack of cash won’t be the only reason why the shop strategy will be abandoned by late 2013; management didn’t go into the level of detail given for Q3, but said shops “continued at the same exceptional rate during the fourth quarter”). As a remainder, the company’s next debt maturity isn’t until 2015 ($200M of 6.9% Notes); as noted above, I will provide a much more detailed discussion when we get the 10-K.

CONCLUSION

To close, I want to note something that I think is commonly overlooked (exaggerated may be a better word): some people believe that consumers will NEVER return after the pricing fiasco of 2012. I have a question: for the customer who stopped coming to JCP, solely because they stopped having sales and offering coupons, where was the loyalty to begin with? If that person ONLY came to the stores with a coupon in hand or when summoned by a TV or newspaper ad proclaiming “20% OFF!”, what would hinder his return when the same approach continued – albeit after a twelve month delay? Some people will undoubtedly feel scorn for the company and swear off ever returning again, and I’m certainly not predicting that sales regain all their lost ground when the sale spigot is reopened; I would simply point to a recent ad campaign the company ran that focused on cost savings, as noted on the call: “Three weeks ago we launched a campaign called “Compare” which establishes a great value of our everyday prices by comparing our key items with those you would find elsewhere. We saw an immediate jump in traffic and sales the moment these ads began.” How big of a jump is naturally up for question, but my point is this: as JCP returns to this space, I think many people could be surprised by the reemergence of the bargain shopper; couple this with the continuation of the proven shops strategy (granted, over a short period of time), and I think we're seeing a more likely iteration of what JCP could become.

I continue to view this as a multi-year transformation; I’m a bit reserved in my opinion until I have a chance to do a thorough reading of the 10-K (and am not looking for much improvement in near term results), but at this point I remain steadfast in my belief that the risk/reward balance favors the long term JCP investor at the current valuation. Until I get the annual report in hand, I will likely not add to my position in JCP; as always, I welcome your comments.

About the author:

The Science of Hitting
I'm a value investor, with a focus on patience; I look to buy great companies that are suffering from short term issues, and hope to load up when these opportunities present themselves. As this would suggest, I run a fairly concentrated portfolio by most standards, usually with 8-10 names; from the perspective of a businessman rather than a market participant / stock trader, I believe this is more than sufficient diversification.

I hope to own a collection of great businesses; to ever sell one, I would demand a substantial premium to the average market valuation due to what I believe are the understated benefits to the long term investor of superior fundamentals and time on intrinsic value. I don't have a target when I purchase a stock; my goal is to replicate the underlying returns of the business in question - which if I've done my job properly, should be very attractive over many years.

Rating: 4.3/5 (17 votes)

Comments

Dr. Paul Price
Dr. Paul Price premium member - 1 year ago


Retailers can go down in flames quickly.

Once vendors/factors see financial weakness they often halt shipments of new merchandise or demand cash up front. That can strip away the chance for a rebound as the lack of fresh SKU's make shoppers even less likely to come back than before.

It's a vicious circle. Current problems beget even bigger future problems. JCP may not have the cash reserves (at their current burn rate) to survive long enough to turn around. Bankrputcy is not out of the question.

Why play with such a risky stock?

swnyc2
Swnyc2 - 1 year ago
Dear Science.

Nice to see you back writing here again! Where have you been?

I'd be interested in your thoughts about JCP's downside risk, which you've not written much about in your past articles. In other words, what happens if Johnson fails? Is the worst case scenario that they decide to liquidate the company? And if so, what does it mean?

Bill Ackman has said that the real estate replacement costs are $11+ billion. The market obviously disagrees, since JCP's current market cap is< $4 billion.

Whitney TIlson has said that the real estate assets are worth $12-$15 per share.

However, I wonder how realistic that estimate is, since many big box retailers (such as OMX, ODP, SPLS, BBY, SHLD, WMT, etc.) are either downsizing, not doing well, or looking at smaller box formats?

If I had a better feeling for the downside risk, I might be willing to buy more shares, particularly if the price goes lower. (My portfolio's exposure is 3%, which I believe is less than the 15% you currently have in your portfolio.)

Regards,

nicktfranklin
Nicktfranklin - 1 year ago
Do you think you made a mistake by investing to early? I went to look at JCP a couple of months ago and walked away with the impression that the turn around could work and was probably a rational response, but that I didn't have any reason to believe a turnaround had taken hold or that the value of the future franchise was worth the opportunity cost I would endure during the turn around. Generally your article is impressive in that you do not shy away from the problems that the investment and company has had, but to be more direct, do you think you were wrong, not in terms of whether the company will be profitable or have economic value, but in wether it was a good investment at the time you made it?

rahimi88
Rahimi88 premium member - 1 year ago
I think quite a few high profile value investors have got themselves into retailers selling at a discount to intrinsic value. However, I always come to think of two WEB quotes regarding these situations and his experience at diversified retailing when he bought some department stores.

When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.

Time is the friend of the wonderful company and enemy of the mediocre.

I think it is the second quote that time could be significant factor that could lead to a much return over time regarding both sears and JCP.
The Science of Hitting
The Science of Hitting premium member - 1 year ago
Dr. Price,

That's certainly true; however, if one takes a close look at the financials (namely $3B in short term financing, beyond current inventory levels - which are clean after 2012), I really think this is quite unrealistic; add in other asset values, the ability to engage in sale/leaseback transactions, AND the fact that shop suppliers have continuously noted the success of the concept (as we saw in the Q3 numbers directly, and as management pointed to on the Q4 call), and I really don't think this is as "risky" as it might seem at first glance. Thanks for the comment!

Swny2,

Been busy! Hopefully I'll be able to add more this month than I was able to in February.

Downside risk is difficult, especially in terms of real estate liquidation value (also in terms of what management could spend between now and liquidation - with 2012 results showing just how true that can be). You can look at SHLD as an example, with Eddie Lampert noting that the company netted about $1B on 300 liquidations since 2006. I would note one major difference - JCP owns many stores, either outright or effectively (via long term leases at below market rates), a condition that doesn't apply to OMX, ODP, SPLS, BBY, etc.

On your last comment, I agree: that's why I'm not buying today; once we get the 10-K, I plan to do a thorough review of the financials, as well as take a close look at real estate as reported for al available annual reports. At that time, I will report back to readers; thanks for the comment!

Nicktfranklin,

That's a good question - and I think I answered it a bit with my "JCP - A Consmer's Perspective" article: it really shocked me just how big these stores really were, and more importantly, how much of the merchandise simply had no place in JCP in today's world. Whether or not that's being early or inadequate research is up for debate; in terms of intrinsic value, I still believe that the original investment was justified by the market price at the time - a reality that I think will become more apparent in the coming years (with much help from real estate and other assets that offer JCP the flexibility to continue with this transformation). Thanks for the comment!

Rahimi88,

I certainly won't quarrel with WEB quotes - and I might just learn my lesson long term with JCP. Time will tell whether the changes being made have improved the economics of JCP's core business; thanks for the comment!

aagold
Aagold premium member - 1 year ago
I'm not normally one to sell a stock on bad news that causes the stock to crash, but I have to admit I sold my JCP the day after they announced Q4 results. Normally I'm more likely to buy more while everybody else is panicking. But not this time. Those results were just *so* atrocious that I no longer had any confidence that the equity's intrinsic value was higher than the market price (~$17.90/share at the time I sold).

When I go back and look at Ackman's Ira Sohn presentation, the situation as it exists now makes his analysis look very unrealistic. Here's the problem: when you've got revenue declining at rate of 32%/year (adjusting for the 13th week in the quarter), that's just too much to bear. There's now way too much fixed cost in the system, so I don't see how they're going to be able to avoid closing a large number of underperforming stores to focus on the better performing ones. And that means revenue will decline even more while debt stays the same. I can't say I've done a detailed analysis of all this, but the whole thing seems like such an unmitigated disaster that I no longer felt comfortable that I had any margin of safety holding the stock. I mean, I think they lost something like a half-billion dollars in a single quarter! (I haven't gone back to check the numbers, but I think it was something like that.)

Another concern I have is that they've been trying to bring back promotions and coupons for a while now, but sales keep declining more. Now that they're bringing back *weekly* sales hopefully things will stabilize, but I'm beginning to wonder if there's something more going on than simply elimination of sales/coupons. I'm beginning to think that the new merchandise itself, as well as the new marketing message, doesn't appeal to JCP's core customer.

I'm going to keep a close eye on this one, and I may get back in if I become re-convinced that the intrinsic value is far higher than the current market price, but as things stand now I'm much more comfortable being on the sidelines.

- aagold
The Science of Hitting
The Science of Hitting premium member - 1 year ago
Aagold,

Thanks for the comment, and agree with a lot of it whole-heartedly; the one point I would touch on is closing underperforming stores - the ratio isn't revenue to debt, particularly if debt is reduced via store closures (due to net gains that may be attained by closing underperformers); I'd point again to what Mr. Lampert said in Sears annual letter as an indication of how store closures could play out over time, if necessary.

Also, the next long term debt coming due is $200M in 2015, so quite a way to go for a relatively small amount (JCP current has $3.7B in current assets against $2.6B in current liabilities). With those things said, I certainly will not dispute that 2012 was very weak; if increased promotions don't drive traffic and sales, funding the transformation (or justifying its continuance) looks increasingly difficult. After heading to JCP this weekend (and happy to see what looked like stronger traffic), it's clear the transformation in home is being prepared for (light inventory to say the least), and will be CRITICAL to the continuation of the JCP transformation as well know it.

aagold
Aagold premium member - 1 year ago
Science,

Taking things as they stand today, do you have an estimate of JCP's intrinsic value? And if not, how do you justify holding it in your portfolio? I think it's extraordinarily hard to estimate it, or even give it a lower bound. In the absence of an unbiased and qualified real estate appraisal it's hard to know what the true liquidation value is. While I'm sure it's true that much of the owned real estate is worth more than what's on the balance sheet, I'm sure it's also true that the leasehold improvements are worth less than what's on the balance sheet if the leased stores are closed. I haven't read Lampert's discussion of Sears so I will check that out... maybe there's something I'm not getting.

What I'll probably do at some point is re-do Ackman's analysis given the information we have today, to arrive at a new estimated fair value. I used to think JCP's fair value was $70/share, because I thought Ackman's assumptions were pretty conservative (at least those in the first part of the presentation, before the "Think Big" section). But given the decimation in sales it's hard for me to see how this thing even becomes profitable at all without a massive reduction in SG&A. The problem is, they've already massively cut SG&A, both at headquarters and in all the stores. There are now noticeably fewer sales associates in the stores, so it's hard to see how they cut that much more. I think closing underperforming stores will help stop the bleeding in terms of P&L, but then the revenue reduction is basically permanent (actually, even more severe) and it's hard to see how the intrinsic value will end up being higher than the current market price.

I think a lot depends on how much, if any, of their core customer traffic they can recover now that they've brought back weekly sales and coupons. If the previous customers quickly come back in significant numbers then that would change my mind, but as I've said I suspect the problem runs deeper than sales/coupons... I do think their core customer felt alienated by the changes and it's not clear they'll come back now.

In hindsight, it would have been *so* much better to have done this differently. They could have maintained brand integrity in the new shops (new JCP) by not offering sales on those items while leaving the rest (Old JCPenney) unchanged. Ron Johnon really took a huge risk in changing so much so fast, and now he's very obviously paying the price. Unless this gets turned around within the next couple of quarters I think it's clear Johnson is out and this will go down as one of the biggest fiascos in US corporate history. I do hope things turn around though and I'm able to get back in... I like JCP and am rooting for them. I just don't want to risk my money on them at this time.

- aagold

The Science of Hitting
The Science of Hitting premium member - 1 year ago
Aagold,

Thanks for the detailed question; I plan on putting my thoughts together on these topics in the form of an article once the 10-K is released. My original thinking on intrinsic value was $6-8B, without any real benefit from the transformation beyond the cost controls being implemented; after the past year, it certainly is lower (clearly I must think the drop-off is much less than other people do, otherwise I would be out as well) - but I need to take a look at the 10-K before I can put a number on it.

I was certainly never near $70 per share (remember, I sold half my stake originally in the low 40's when this all began, as I think I've noted previously in comments or an article), but was well above where we are today. Again, not to dodge the question, but I will address this all in an article once we get the 10-K; I really want to take a close look at it so I can give you the best answer I'm capable of, and I think it will answer a lot of questions I have at this point in time.

In terms of alienating core customers, I'm worried you might be right; I'm hoping Zyman learned from his mistake at Coca-Cola and will quickly work to regain the trust/respect of core customers.

As you note, in hindsight, this could have been pulled off much differently; it was sold as a required change to attract new brands, which now appears to be false. Ron took a huge risk, and shareholders are paying the price; in my case, that price was entirely deserved - I was wrong about the pricing strategy, and supported it even though I knew it would be a tough transition (certainly not -32% though).

What happens if JCP "shops" don't work is interesting to contemplate...

Thanks for the comment!

swnyc2
Swnyc2 - 1 year ago
Aagold,

I think your concern about the long term implications of JCP's losing core customers is misplaced. Conventional retail is a narrow moat business. The very fact that so many customers deserted JCP so quickly is a testament to this.That's the bad news that everyone is focussing on. The good news is that in narrow moat businesses, revenue can increase just as quickly - provided there's a reason.

I don't think Ron Johnson and his team are trying to attract the old JCP customers. They are appealing to new customers by re-inventing the shopping experience and providing more hip and fashion forward goods. In essence, they are trying to build out a new retail business by taking over the old JCP real estate. They are also hoping that this new retail experience will grow their moat.

In the long term, management (Ron Johnson's team or their successors if the Board so chooses) will find a way to make JCP at least as successful as other retail stores (and likely more so). In the meantime, the question is how long will it take, and how low will the stock go. This uncertainty is what makes JCP such a difficult investment.

The fact that Vornado dumped 50% of their shares today, will put more pressure on JCP's stock price. If Macy's succeeds in court and blocks JCP from selling Martha Stewart's home line under the name JCP Everyday, that will put even more pressure on the stock. The fact that JCP's real estate is worth $12-$15 per share (according to Whitney Tilson) will put some kind of floor on the stock price.

Because JCP is such a risky investment, it comprises only a small portion of my portfolio. However, if the price were to fall into the $12-$15 range, I think the potential upside could substantially outweigh the downside, and I'd consider adding meaningfully to my position.

Science,

Stick to your guns!

aagold
Aagold premium member - 1 year ago
Swnyc2,

Ummm... it's *not* always correct for a value investor to "stick to his guns". A rational investor takes into account all new information available, both positive and negative, to update his/her estimate of intrinsic value and then make a buy/hold/sell decision.

From the tone of your comments, it looks to me like you're unwilling to acknowledge the negative information being revealed. I mean, how bad would the news have to be for you to say it's ok to sell? I can tell you this - if one year ago, when Ron Johnson unveiled his plans for JCP at the very high profile event for wall street, someone who had access to a time machine pulled RJ aside and whispered in his ear, "Pssst... you better be careful... in the Q4 Christmas quarter of 2012 you're going to lose $552M (after tax!), same-store sales will be down 32% year-over-year, and Internet sales will be down over 34% year-over-year", RJ and Ackman would have just chuckled and said "Oh please, that's ridiculous... go away". But that's exactly what happened.

Don't kid yourself... those Q4 results were truly off-the-charts bad, and JCPenney can't remain a going concern unless things change dramatically and very quickly. Attracting new customers is a good growth strategy but it's not going to happen overnight. They need to recapture at least a good chunk of their lost customer base, cut costs and close stores to become profitable at this new lower base revenue level, and then use the new shops to grow the business over time.

- aagold

swnyc2
Swnyc2 - 1 year ago
Dear Aagold,

I never said it's always correct for a value investor to stick to his guns. In this instance I said it because I believe Science's original thesis is still correct. It just may take a little longer than he (or JCP management) originally thought.

I freely acknowledge the negative financial information being revealed. However, I've learned through experience that most worthwhile endeavors take longer to achieve than originally estimated. I think JCP management has already acknowledged this.

I'm not kidding myself. The Q4 results were bad, and were worse than most people expected. However, as Science has pointed out, JCP still has enough cash to continue with its plan for at least another year. The retail space where JCP sits is largely a moatless business, which means customers can return as quickly as they left.

I disagree with your statement that JCP needs to "recapture at least a good chunk of their lost customer base." I agree that JCP needs to increase revenues (and decrease expenses), but it doesn't need to come from the same customers that used to shop there.

At $14.96, JCP is currently priced at liquidation value. There's a reason for this. The market recognizes that JCP is a risky investment. I realize this too, which is why JCP doesn't comprise a large portion of my portfolio. But, I also believe there is an opportunity for an outsized return.

Finally, consider this: most stocks have gone up over the last 4 years and they cannot keep doing so indefinitely. For the sake of diversity, I'm attracted to JCP because its performance is likely to be less correlated with the market in general, which could be helpful in the event of an eventual market downturn.

Thank you for your comments.

Regards,

aagold
Aagold premium member - 1 year ago


Swnyc2,

Even in a low-moat business, customers do have habits. If they buy a product or service from one vendor, and they're satisfied, then they tend to continue buying from that vendor. If this were not the case then there would be no correlation between a business's sales one quarter to the next or one year to the next, right? The revenue stream would just look like random noise with no persistence from one period to the next, and there would be no point in tracking how revenue in one period compares to that of any previous period. Well, obviously that's not how the real world of business works. People have habits, and sales in one period are a very good predictor of sales in the subsequent period (accounting properly for seasonality, if necessary). So it seems to me that the only hope of reversing the sales decline quickly enough to keep JCP running as a going concern is to recover a significant portion of the lost customer base, the hope being that customers who had the habit of shopping at JCP but broke it recently (due to lack of sales/coupons and/or feeling alienated by the new marketing and merchandising) can be persuaded to return. Otherwise the company will be liquidated or sold before the transformation has enough time to take hold.

Also - I doubt the liquidation value is $14.96/share. Their book value is currently $14.41/share and they just lost $6.98/share pre-tax in 2012. And yes, I know that the owned real estate is worth more than what's on the balance sheet but the leasehold improvements in the leased stores are worthless if the stores are closed down, so I don't know which effect dominates if the company is liquidated. And I do think it's relevant that Vornado just sold 40% of their shares at $16. They would know better than anyone what the real estate is worth, and if they really thought $14.96 was the floor then there's no way they would have sold at $16.

Regards,

aagold

mygift
Mygift premium member - 1 year ago
I concur with swnyc2 except that few-to-no retailers have a moat--where are the economies of scale, customer captivity and patents that generate excess returns. I will give you Costco and WMT^ in its early days. I have been in several stores at different times. I must say, overall I was impressed by the value/price relationship. Stuff was cheap; it made wonder how they make $. The BEST that JCP can do is to earn a fair return on their capital which they use to own or lease space.

But the quandary is old customer vs. new customer. If you saw their Super bowl adds and their Gay spokeswoman, you know they are appealing to a younger, more upscale, urban audience, not the "dowdy" housewife. You are talking different merchandise, layout, advertising, etc to attract a certain customer, so this transformation--if it will be successful--will take 5 to 10 years. In my mind, I wish they simply sold the old JCP and started fresh as a start-up. This is like running a decaying business while starting a new one. Tough! But the old JCP was guaranteed toast. The interesting thing about $40 and $15 is that nothing has changed in the transformation process. They said they needed to cut costs, improve management/tech systems, clear out stale inventory and roll-out stores within stores. What "surprised" people was the drop in sales. What people forget is that habit is everything. The shopper knows nothing but the coupon/sale, so beware trying to change a person's habit. Conversely try STOPPING people from buying their coffee in the morning from Starbucks. I once tried to pay people $20 NOT to buy their coffee at the local Starbucks but was unsuccessful--NOW that is CUSTOMER CAPTIVITY--hence Starbucks high ROIC and rising stock price.

If I were management my goal would be to sell off poor performing stores, focus on attracting as much traffic as possible to the stores and track the results of your start up operations. Obviously, Johnson realizes his mistake now of doing too much too soon. But I am surprised at how surprised people are about the results--didn't they visit stores and talk to customers? Traffic looked light during the weekdays that I visited.

I am not the typical customer, but the stores look cleaner, better lay outs--much improved. What hit me is how big the stores are and not all the space is needed?

If people have patience--the stock will be rocky for awhile--who in their right mind would be bullish? the results in the new concepts should show traction--I like the idea because the manufacturer might have more say/control in display, advertising and marketing. Manufacturers need the retailer.

The bigger issue is secular decline. Does America need Sear's, Macy's JCP? However, people do need to go to a location and see, feel and try on clothes--it can't all come from Amazon.

I might be a buyer under $10 because I think they have enough organizational, trademark and real estate value if the bleeding is staunched within 18 months.

Go where the hatred and despair is greatest. Also look at small gold mining stocks.

stevenramsey
Stevenramsey - 1 year ago
I don't have much to offer here, except to say the conversation on this page has been some of the most quality conversation I've ever seen on a stock on the internet.

Buffett had a basic, but powerful thought on JCP this week (appearance on CNBC) when he said that doing something your customer doesn't want, in retail, is not a smart decision. That's a simple insight that can change an entire thesis on an investment.

I bought JCP in the high $20s, doubled down at $16ish a few months ago, and now sit with a large paper loss. This could end up poorly. But the lesson learned for me personally is that there are easier ways to make good money, instead of going for the long ball/retail turnaround. I'm not kicking myself too much for this one, since I thought there was some good reason for going into the company:

- great manager (I still think Ron Johnson is incredible as a retailer; and courage inevitably leads to failure and success both)

- under-utilized assets (brand name, real estate value)

- a dynamic strategy that included huge cost cuts (that have been achieved btw)

- Ackman laid out how the reward/risk ratio was 4 - 15:1 if the plan worked

I'll hold long enough to see if things turn up and long enough that this lesson gets pounded into my soul.

All in all, great insight everyone.
ramands123
Ramands123 - 1 year ago


Please also note that Buffett also said "Price takes care of the future "... If you bought JCP cheap enough you should do fine..

How can a lomg term investor judge Managment if only 10 % of thier strategy has been in place till ... They did a mistake and they corrected it from begining of this year.. Lets have some patience and let thier strategy play out ..

They have no bonds due till 2015 , so they are not going bankrupt.. And even if they do, at current prices you will get majority of your money back.

Worst case scenario sales don't improve, they fire Ron Jhonson and they go back to thier basics of inflated coupons and sales on underwears and socks...
ramands123
Ramands123 - 1 year ago
Also it is one of the most shorted stocks and we all know what happens when there is even a small amount of good news.
The Science of Hitting
The Science of Hitting premium member - 1 year ago
Just to address the last two comments (thanks to the others for posting as well):

Stevenramsey,

"I'll hold long enough to see if things turn up and long enough that this lesson gets pounded into my soul." Based on my current thinking (subject to change), I'll probably be right there with you...

Ramands123,

Good point on the 10% - which, by the way, is working; in regards to patience and the bond maturity, just remember that you can spend your way to bankruptcy as well; personally, I think the company needs to essentially say "we're sorry, here's a big sale to draw you back to the stuff you want", and focus on adequately addressing both needs for the time being (with VENDORS choosing to run their business as they see fit in the shops, fulfilling the need to attract quality vendors/brands - the whole point of the transformation).

In regards to returning to where they were, JCP was bringing in EBIT of roughly $800M-$1B in the 5-7 years prior to the financial crisis - surely boosted by the housing bubble, but worth noting; getting back to that would be very difficult, but I certainly don't rule it out as 100% impossible as many seem to be doing.

Thanks for the comments!

swnyc2
Swnyc2 - 1 year ago


Aagold,

With regard to your comment on customer habits, I think we will have to agree to disagree.

In this moatless retail business, those coupon cutting customers who used to shop at the old JCP would return like ants to honey if management stocked the store as they did previously and pursued the same heavy promotional strategy.

Regarding your point about Vornado's selling 40% of their shares at $16+, I could make the point that they decided to keep the majority (60%) of their shares. And remember, in every trade there is always a counterparty taking the other side. So, the shares that Vornado sold had to be purchased by someone else, who presumably liked the valuation. I'm not knowledgable or experienced enough to determine accurately what JCP's real estate is worth. For now, I'll accept the $12-$15 per share that Whitney Tilson estimated. Vornado could have decided to decrease their exposure because they didn't like the risk, even if they thought the stock was attractively valued.

At the end of the day, the question isn't what Vornado is doing, but rather what we individual investors should do? It's my opinion that management will succeed, provided they have enough time to build out the new shops. My belief is grounded in the fact that JCP will offer a very nice and new shopping experience that won't be found elsewhere. I think Mr. Market is overly pessimistic and fearful right now.

Regards,
aagold
Aagold premium member - 1 year ago
Swnyc2,

Actually we don't really disagree all that much. You said, "those coupon cutting customers who used to shop at the old JCP would return like ants to honey if management stocked the store as they did previously and pursued the same heavy promotional strategy". I think that is indeed possible (although not probable), which is why I said I might get back in to JCP in the future. What worries me, however, is that so far their attempts to bring back coupons and sales havn't succeeded in bringing back their previous customers or even stemming the continuing sales and gross margin declines (as a matter of fact those declines have become increasingly severe despite increasingly promotional activity on JCP's part). Maybe going to weekly sales will finally have that effect, we'll have to wait and see. As I said, I worry that the change in marketing and merchanising has alienated the previous customers in a more permanent way, but I'm not sure. Time will tell.

But in the end, I base my investment decisions off of analysis and intrinsic value calculations, not qualitative statements or ideas of the type we've been discussing. And as one of the analysts said in a recent report, "the arithmetic doesn't seem to work" when you look at the income statement and balance sheet and use reasonably conservative estimates going forward. But as Keynes famously said, "When the facts change, I change my mind. What do you do sir?"... that's why I sold my JCP at $17.90 but may get back in later if a cold hard dispassionate analysis shows that expected intrinsic value is much higher than current market price.

Regards,

aagold

Please leave your comment:


Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)
Free 7-day Trial
FEEDBACK
Hide