JC Penney: A Proposed Investment Strategy
Right now, the subsistence of the company depends on the success of the current turn around. As huge volatility should be expected going forward, let's take a look at the company's last quarterly results and propose a viable investment strategy.
JC Penney's third quarter results.
Even when the company's figures continue to be extremely weak, third quarter results and the company's fourth quarter guidance point towards a successful turn around. Same store sales (the most relevant figure in retailing), which were down by 4.8%, are ameliorating fast albeit against easing comparisons. Besides, the company is more aggressively controlling costs and preserving its capital. That said, JC Penney reported a third quarter adjusted EBITDA loss of $240 million (10 times lower than the $23 million loss a year ago) and missed on top line and bottom line figures. Moreover, Gross margins declined to 29.5% from 32.5% in the prior year.
The positives were driven by strict expense control as SG&A expenses declined by 7.5% to $1 billion from $1.1 billion a year ago. On the other hand, including the proceeds of third quarter's equity issuance, JC Penney's liquidity improved to $1.7 billion while the company repaid $200 million on its revolver financing facility.
The Road Ahead
Results were bad, but better than what was expected by the market in one key figure: same store sales. JC Penney's management seems to believe that the turn around is taking hold. As a matter of fact, the company expects same store sales to turn positive for the coming quarter. In addition, the company's CEO, Mr. Myron Ullman – who returned to the company in April this year – bought $1 million worth of his company's shares.
I strongly believe that the decision the current management took regarding strategy – going back to discounting and promotions - is the correct one. Now, we shall have to wait and see. I would not expect JC Penney's EBITDA to turn positive until at least 2015 but the stock will move sharply in the next few quarters in the light of early signs of future success or failure. Great investors such as George Soros and Mario Gabelli seem to be thinking that management will succeed since they are long on the name.
The Proposed Investment Strategy
As I mentioned before, it's very tough to value a business which is in the middle of a turn around. That said, huge volatility in the company's stock price is to be expected. Hence, I would recommend buying volatility which is the same as buying “out of the money” call options (going long) and “in the money” put options (going short). You will lose your whole investment on one of the two legs of your trade but you should win big on the other leg on the light of terrible failure or great success.