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The Science of Hitting
The Science of Hitting
Articles (494) 

JCP - A Consumer Perspective

October 18, 2012 | About:

Last week, J.C. Penney (JCP) CEO Ron Johnson sent out an email that caught the media’s attention for the following three sentences:

“I’d like to invite you into your favorite jcpenney store to see the changes firsthand. As an incentive, I’m enclosing a $10 gift. Think of it as a thank-you from jcp for your loyalty throughout the years.”

The analysts following JCP are a smart bunch, and got right to asking the hard questions that will help them determine the viability of the company’s long-term strategy. For example, should the $10 be considered a coupon or a gift? (In case you can’t tell, I’m being facetious.) Here’s what an analyst at Deutsche Bank had to say in a note titled “$10 Off Is A Coupon In Our Book:"

“In our view, this serves as another admittance that the ["everyday low prices"] strategy transition continues to be difficult and on the heels of a month-long kids haircut giveaway in August, it shows that the management team is actually willing (and looking) for promotions that will aid the store draw traffic.

As we approach Black Friday and the Holiday period, we would not be surprised to see additional coupons and promotional events provided by JCP.”

Brian Sozzi, an analyst at NBG Productions, said the following: "It's a coupon rebranded… This tells me that the traffic problem continues."

As usual, I think the analyst community is asking the wrong questions (largely due to the fact that they’re only focused on near-term traffic – as indicated by Mr. Sozzi’s conclusion); I agree that this move is all about traffic, but think the conclusion misses the forest for the trees: Does anybody really think that this $10 “incentive” – whatever you like to call it – is what management was targeting when they announced their plans for the future? Is this in any way comparable to what “coupon” meant in the J.C. Penney of two years ago, the increasingly promotional environmental that I’ve discussed in previous articles?

The answer is no; the target was endless hours wasted by employees switching in-store signage rather than focusing on providing quality service to the customer. And I don’t think that vision has changed at all (in the recent words of Johnson: “We are always going to tweak the tactics, but we won't change the vision”).

While I’m not interested in the debate about whether this is a gift or a coupon (that discussion is the definition of noise), I am interested in the status of the transformation. As such, I felt it was a good time to revisit the stores to talk with employees about the changes they are seeing, and to look at the story from the perspective of your average consumer.

I spent a good hour walking through the local JCP, and spent time looking at merchandise and watching other consumers, as well as talking with associates. On the first part, I have a couple observations that other investors might be interested in (or have shared on their own store visits):

1. The shops stand out. The design and lighting in the shop sections is noticeably different than in the remainder of the store, and the layout certainly looks much less cluttered and higher quality. However, from what I saw (remember, all of this is anecdotal, and any observations should be considered in that context), these sections were not any busier than the other sections on average.

2. Your average Penney’s is very, very big. As the company has noted, most stores will have 100 shops upon completion, meaning that there’s still a long way to go with roughly 6 shops per store at this point. When I walked through the store, this was apparent: So much of what I saw looked unchanged, which likely explains why the response by some consumers (people unfamiliar with the long-term vision) who have visited the stores and expected a big change hasn’t been too positive. I think this is a critical problem that the company is facing, and will continue to face – the balance between maintaining a decent level of traffic (which means still having people show up, likely through promotional events like free haircuts or $10) and actually getting to the point where broad change becomes apparent will be a long and rocky road. And my impression is that it will take more than a few shops (25 or so) to overcome this issue.

3. The company sells a lot of items that seem out of place. 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 Penney’s 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 Walmarts (WMT) and Amazons (AMZN) of the world is still a bit unclear to me.

4. Clearance is popular. Among the busiest sections I found in the store were the clearance racks; many of the people in these sections are what I would describe as your typical Penney’s shopper. I think the target consumer won’t be a frequent guest in the store until the company seriously boosts the marketing spend, and I think letting off the gas for the time being is the right call. As noted above, you risk alienating potential customers for a long time if they show up with expectations of revolutionary change, only to find the same old JCP they’ve always assumed was there (the one their parents dragged them through as a kid for us younger folks).

The Employee Perspective

Besides my own experience, I made an effort to talk with associates about the change; all of the people I talked to recognized that change was underway, but some admitted that they didn’t have a clear vision of the end goal, which I think (if it’s a result of inadequate communication) is a major error on the part of management. When I asked above traffic, the general response was that it was so-so, with no indication that it had changed in a big way over the past few months.

Despite what some people might assume, the older associates actually appeared the most interested in the change (of the people I spoke with). Maybe they are simply the most concerned about keeping their jobs in this economic environment, but my impression was that they were genuinely excited about the new direction. And many of them were walking around greeting customers and actively engaging in customer services, rather than changing out clearance signs.

Overall, I would conclude with the following: My impression is that this transformation will not only take years to be completed, but that the rebound in the financials may be delayed for longer than many people assume. As an investor (and someone interested in adding to my holding at the right price), I would be very cautious when entering a position (demand a sizable margin of safety to account for the length of time between value and price convergence, and the inherent uncertainty in the changes proposed). Let the irrationality volatility of the market provide you with opportunities as opposed to looking to its gyrations as an indication of success or failure.

Again, as I noted above, this is anecdotal, and should all be taken with a grain of salt. I would love to hear the opinions of others who have recently visited a JCP location if they are willing to share their thoughts. I will update readers on the financials after the next conference call.

About the author:

The Science of Hitting
I'm a value investor with a long-term focus. As it relates to portfolio construction, my goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach to investing is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with a handful of equities accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

Rating: 4.1/5 (26 votes)


Nikhilindya - 6 years ago    Report SPAM
I recently visited a JCP store and actually ended up buying a shirt. (my 1st ever! at JCP) . That being said, the overall mood at the store was gloomy to say the least. Escalators under repair ( or may be that's because of the change that's underway.) I did see the new lighting and that was good.

My overall impression was, its not there yet.
Rafaelscremin - 6 years ago    Report SPAM
I visited a JCP store too, and I saw positive changes. I think that the transformacion will be a great success, I like the idea and a lot of customers are visiting the store for the first time

The Science of Hitting
The Science of Hitting - 6 years ago    Report SPAM
Nikhilindya and Rafaelscremin,

Thanks for the interesting perspectives on the JCP transition.
Tonyg34 - 6 years ago    Report SPAM
Didn't we play this game at Sear's back in 06 ? - retail is all about margins and JCP simply can't compete with AMZN or industry loss leader COST
Ttony - 6 years ago    Report SPAM
JCP is absolutely nothing like Sears. JCP is attempting to add a completely new category to the department store mix. That transformation will take time but the payoff could be extremely large. But it will take patience. Just the technology change will take three years. JC Penny had 500 custom software programs so that 95% of their technology spend each year was for maintenance. This will change.

A year from this Xmas they expect only 40% of their base 700 stores to have been changed to their new format. Their buyers will have to adjust to a completely new experience. Inventory will be much less. But when it is accomplished, bumps along the road and all, what will we have? A new shopping experience for the customer. Technology will make their shopping easier; both in fit and in check out. Instead of horizontal tables piled with messy stacks, they will see vertical displays. Instead of endless racks they will have aisles of separate stores-each a different shopping experience. That is the core of the idea...duplicate the mall in one store.

They say that each mall shopper traditionally visits about five stores per visit. In the completed JCP stores...maybe three years....a consumer can easily visit 25 in the same period. And those stores will be fresh because JCP will be able to offer new and very different vendors to the consumer. Many of these vendors would not otherwise have representation in the mall. If you are a wonderful small vendor with limited representation across the country why wouldn't you want to immediately have access to 700 stores across the country in YOUR OWN SPACE. The vendor will have much more control how his wares are shown. The trade off is that he has to agree to hold his prices down as JCP wants to continue to offer low prices. But since the vendor does not have to rent space, etc. as a stand alone store, he can afford to lower his prices.

The payoff for JCP down the road is much lower costs; they have already shown that they are far along of their initial target of a $900 million reduction in overhead. Less inventory and better use of technology will also lower costs. But the big payoff should, HOPEFULLY, be a much higher sales per square foot for them. Moving from the traditional department store range toward the specialty store range. Folks....that is big money.

Yes we have the transformation to go through. But watch closely how the media reacts to each announcement. They are negative as they are mostly negative about just about anything new. When JCP flubbed their initial marketing, the media/analysts crushed the stock. When Johnson fired the head of marketing, the media/analysts crushed the stock. But while acknowledging that the mistakes were made, I was thrilled that Johnson acted so decisively so quickly. And then rather than trying to spend his way out of the muddle with ad dollars, he cancelled all ad spending to think it over. That is a wow...no panic...again such a wow.

And now they have a traffic problem so they offer a ten dollar coupon to get people into the stores. The media goes crazy saying that JC Penny is reversing its policy of no coupons/sales, etc. But it is a smart ad spend as they want to show their new layout and ten dollars per customer is smart. It does not require that endless employees retag stuff.

The market is pricing this stock at its current price because:

1. Thinking of the failure of Sears

2. The Ellen problem...lots of shoppers didn't like a gay representative.

3. Confusion over the change over in pricing..bad initial pricing.

4. Firing of the marketing guy.

5. 20% drop in sales.

But what we have is an extremely smart owner-Ackman, and a brilliant manager-Johnson. They will correct the mistakes as they go. They are extraordinarily proven people. Read the Jobs bio....how does someone survive that sort of leadership? They survive by being astounding good at their job. Johnson is that.

What is the company worth? Well the market was pricing the stock higher when it had 20% more crappy sales with $900 million more overhead and a down trending future.

This is a honey of a story for an investor who has a three year horizon..
Ttony - 6 years ago    Report SPAM
One other thought....totally agree with you on the home department...it sucks...it is the old JC Penny. But Johnson can only do so much so fast. This is such a big job and I sense he is concentrating on the main task which is the initial 40 shops in the 700 big stores, overall presentation in the stores, inventory control, and technology. Things like the home section, the 400 smaller stores and the online business will have to wait their turn. Too much to do to try to solve everything at once.
Tonyg34 - 6 years ago    Report SPAM
still sounds like sears

they tried the store in a store concept - craftsmen, home and garden, lands end - no one cared

"extremely smart owner" Ackman = Lampert

you can't "correct the mistakes as you go along" b/c when "brilliant" mngrs get involved in lousy businesses, its the reputation of the business that prevails

maybe you can fall back on the real estate portfolio or an expanding online sales presence, cause that has worked before too
The Science of Hitting
The Science of Hitting - 6 years ago    Report SPAM
Interesting comments - thanks everybody!
Varunfriend premium member - 6 years ago

What is the real estate book value of JCP? ie at what price does it become an asset play with the business for free?
Swnyc2 - 6 years ago    Report SPAM
Dear Varunfriend,

Bill Ackman has said that the real estate replacement value is B, which is $50 per share.

Book value of the entire company including real-estate is $4.8B, which is $22 per share.

Recently, Michael Price estimated the real estate is worth per share.

At today's closing price of $17.97, one could hypothesize that the recently decreasing stock price is fast approaching the real estate value. However, assets are not perfect downside protection as management could choose to incrementally sell off the real estate as it burns through cash in a futile attempt to turn around JCP. The good news is that some major shareholders sit on the board and hopefully wouldn't let that happen. Bill Ackman is one of these investors, and he has said his average purchase price is $26 per share. It's likely that in a wordt case scenario, he'd like to get some of that money back.

JCP represents a risky, but intriguing opportunity. If you believe that management can cut costs and get business back to where it was in 2007, JCP stock should eventually be worth + per share.

If management fails, investors getting in now at $18 per share are likely to get back most of their original investment.

Personally, I think it is likely that JCP will eventually succeed, because the changes management is making will entice people to shop there. The shopping experience they are talking about doesn't exist in the general retail space today. So, even if it appeals to just a small segment of the population, it is likely that JCP will succeed in being as profitable in the future as they were in 2007.

In summary, at $18 per share, the upside is $42, while the downside is close to $3. Even for those who think there is only a 10% chance of success, it's still a good investment.....

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