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JCP - Knocked out Kohl’d?
Posted by: David Chulak (IP Logged)
Date: September 20, 2013 05:02PM

One of my favorite personalities when growing up was football Coach John McKay, who won four national titles while at the University of Southern California. He eventually went on to coach the Tampa Bay Buccaneers, and McKay was never without some sort of quip for the news media, especially when it came to his own team’s horrible record. One of my all-time favorites was as he was jogging off the field with his team after another humiliating defeat for his 0-26 team. Queried about the ineptness of his players carrying out simple plays, he was specifically asked what he had thought about the execution of his team. McKay responded with a simple, “I’m for it.”

On another occasion of his team being humiliated, McKay merely stated, “They were absolutely horrible and that’s the best thing I can say. Besides that they were bad. These people are not poorly paid, you know.”

I’m only speculating (the only speculating I try), but I would suppose that similar conversations went around the board room of J.C. Penney Co. Inc. (JCP) during the tenure of Ron Johnson, along with former shareholders Bill Ackman and Steven Roth. Bill Ackman was a huge supporter of Johnson, as apparently was Vornado (VNO) CEO Steven Roth. The two investors, until recently, held over 25% of the shares and supported Johnson in his effort to transform the company.

That much he did accomplish, only to find a pink slip from the company that had sought out his expertise for renewing the company that displeased their customer base. It didn’t take long for both Ackman and Roth to realize that things were going to change again, apparently, much to their disliking. And they felt the pressure from the remainder of the board until they have both decided to disassociate themselves from the company.

While Penney’s shares have continued to suffer, the former CEO Michael Ullman has returned to the position, accepting a much reduced salary of approximately $1 million, perhaps as acknowledgement of the seriousness of the company’s current financial position.

So, speculation remains rampant as to the future of the company. Every day, articles fill the newspapers and blogs regarding the direction, the potential and future of the company. The company’s gross margins continue to dwindle, revenue continues to disappoint and that is the good news. The more you look, the picture appears quite bleak…and yet hope still remains.

There are several investing guru’s holding shares, even some recognized as high profile value investors such as Mario Gabelli and Chuck Royce but the percentage of shares are not huge or don’t indicate that strong conviction by the amount of shares held that might display confidence in the ability of the company to make a complete comeback. The predominant investors appear to be more growth oriented and seemingly hold larger positions in hope of a turnaround for the beleaguered company. It still remains that investors of both stripes hold sizeable holdings, perhaps confident, perhaps just hopeful that they can see this distressed company return to its former self.

Many have assumed that competitors such as Kohl’s (KSS) and Macy’s (M) have captured the business destroyed by the former regime. The facts don’t fully support that analysis completely. Certainly, if you look at the charts below of both revenue and gross margins, you will note revenue from both Kohl’s and Macy’s are certainly doing considerably better than Penney’s, but the actual numbers do not paint that a picture of two large competitors driving the third one out of business. The gross margin graph for Penney’s gives a clear picture of a nosedive, while Kohl’s indicates a slight decrease; and Macy’s is holding its gross margins relatively steady.

If you continue the analysis, you finds that both Kohl’s and Macy’s performed better than Penney’s, but neither was able to take a great advantage in the current economic slumber and highly competitive retail business by clearly capturing additional market share. Some perhaps, but definitely no knockout punch by either rival. Many may disagree, but the numbers of both Macy’s and Kohl’s are definitely not stellar to the point of Penney’s crying uncle. Both Kohl’s and Macy’s have some advantages currently that J.C. Penney’s doesn’t, but neither has knocked Penney’s out of the running as a viable challenger. Nor have they changed the dynamics to place Penney’s on the run. Truth is, Penney’s has shot itself in the foot, but its competitors are standing still or, at best, slightly gaining some traction. It’s clearly up to Penney’s to decide its fate.

So what opportunities or threats lay ahead for the three competitors, specifically for Penney’s, or what can we use as a compass to guide us in our choices?

The bear case for all three stores remains two-fold: the economy and the trend of malls. Sales have been weak and caution has already been given about the approaching holiday season. Also, in a recent Bloomberg article, it was reported that the mall landlords such as Simon Property Group Inc. (SPG) and General Growth Properties Inc. (GGP) are taking a hit due to higher borrowing costs and the slowing retail sales. In fact, both have divested themselves of less profitable properties.

The issue regarding malls has been an on-going discussion as to their future. Green Street Advisors has gone on the record to state that at least 10% of enclosed malls will be closing by the year 2022, using the property for other uses, apartments, office buildings, etc. Add online sales, more competitors and a highly competitive business model, and the future is very questionable for all.

Kohl’s appears to be the only one of the three that has the room to expand into new markets or is at least inclined to. It continues to expand at a pretty good pace; however, this may hurt it if the economy doesn’t take off any time soon by hurting margins and pressuring same-store sales. More competition and online sales may also affect revenue. Its out-of-the-mall experience or into smaller venues continues to pay off for them.

Macy’s revenue has also been slowing and while the company has been working on a restructuring plan and cutting their operating expenses, the growth expected ahead is limited unless the economy really improves. Will they be able to keep any of the business Penney’s has thrown at them? Perhaps, but now they have to focus on keeping them.

It seems as if neither Kohl’s nor Macy’s has any type of a moat to knock out Penney’s from the circle of competition. The question is, can Penney’s get its core customers back? The updated stores are inviting, but is that enough to get it back for this holiday season and start turning things around? All of the competition appears to understand that this season may be difficult. With Wal-Mart in the lead, layaway plans have started earlier than normal, hoping to capture some additional business. Target, Amazon and Best Buy have all taken note and are offering their own special deals. The way Penney’s has been burning through its cash is worrisome, and it remains to be seen how liquid it can remain. Does it have time to return to its former self? Many believe this season may be indicative of its future.

I do not believe that this season will make or break this icon of a franchise, important as it may be. With that said, investing in Penney’s appears to be pure speculation at this point.

Disclosure: I do not own Penney’s (JC), Macy’s (M) or Kohl’s (KSS).

Guru Discussed: Bill Ackman: Current Portfolio, Stock Picks
Chuck Royce: Current Portfolio, Stock Picks
Stocks Discussed: JCP, KSS, M,
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