The Return of a Proven Strategy
After failing at its re-positioning strategy, J.C. Penney's former CEO, Ron Johnson, had to leave his post to Mr. Ullman, who is bringing back the company's traditional pricing strategies such as special discounts and coupons. As a result, Bill Ackman, who had supported Johnson in his failed turn around efforts, sold his entire 18% stake in the company at a huge loss for his fund (Pershing Square). At the time Ackman was selling, other investors such as George Soros (who owns a 7.9% stake), Kyle Bass (5.2%) or Glenview Capital Management (9.1%) were buying up the shares.
Even when J.C. Penney just reported another sluggish quarter with top-line trends falling well short of expectations and same store sales declining by 11.9%, I agree with Soros. I think there is a future for the company. Management is focused on preserving cash with plans to reduce capex next year to $300 million (from $1 billion this year) and the combination of better merchandising and more cohesive pricing should lead to a significant improvement of J.C. Penney's return profile even when I don’t expect the company to produce a positive EBITDA figure until 2015.
Betting on Real Estate
Set to report its worst EBITDA year since its combination with Kmart and at a time when it's expected to have an $8 cash shortfall per share this year, Sears has gone up by 33% year to date. The reason can be found in the supposedly huge value of its real estate. I disagree with the real estate thesis. The company is 90% controlled by ESL, Eddie Lampert, and a few other large owners. Why would they decide to operate a cash flow negative business if the asset values are so high? Maybe real asset values are not as high or not as easy to unlock.
That said, some big funds strongly believe there is huge value in Sears that could be extracted rather sooner than later. According to the hedge fund Baker Street Capital Management, which holds a 1.4% stake in the company, Sears' real estate value is worth well over $8.5 billion. Hence, on their analysis, the stock is worth somewhere between $88 and $161. This estimation makes the shares look highly undervalued (Sears now sells for about $59). Despite Baker's long and detailed pitch, I doubt about the feasibility of unlocking such value if it were to exist. In other words, at the current price level you might want to avoid holding Sears.
When you buy an asset, “Price is what you pay and value is what you get.” I believe J.C. Penney could constitute a good buy if Ullman succeeds at turning the company around. Great investors such as George Soros seem to be thinking that Penney's CEO has a good chance thanks to his strategy and the on-going economic recovery. Sears is a different story. The bet here is on a dubious calculation of the value held in the company's real estate assets.