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The Science of Hitting
The Science of Hitting
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JCP - CFO Ken Hannah at BofA Conference

March 15, 2013 | About:

J.C. Penney (JCP) CFO Ken Hannah presented at the Bank of America Merrill Lynch Conference on Wednesday, and provided an update for investors (link); here are some of the key quotes from the presentation, along with some of my thoughts:

Management – “I’m not resigning; Ron’s not resigning… Ron and I are not going to go hide; we’re going to tell you what we’re doing, we’re going to tell you what we’re learning, and we’re going to stand up and be accountable.”

Disposal of Non-Core Assets – “We changed everything in the company but the address. And if you read the papers, you’ll see that we’re sitting on 300 acres of the most sought after land in all of Dallas; and if somebody wants to pay me a pretty penny for it, I’ll gladly take our team and put them into something that’s sized more appropriately for the business we have today. We went after every non-core asset that we had on the balance sheet and said ‘how do we make sure we fund this transformation internally?’ So we had a lot of things we had done for many years for tax purposes, and we were able to go in and monetize about $526 million worth of assets – and there’s several hundred million more that we’re working on today… This isn’t a fire sale, we’re not looking to sell our core assets to survive; we’re looking to take our non-core assets and use them as a source of funding.

Shop Launches – “We’re very excited about what we’re seeing in the productivity of the space where we’ve done the transformation.” Next launch is Joe Fresh, across 681 stores, this Friday.

Expenses – “We’ve taken out in excess of $900 million in expense… I think there is still opportunity as we go forward.” Here’s one good example of additional opportunity: JCP spends about $1B on advertising per year, roughly 20% below Target’s (TGT) annual spend – despite the fact that TGT’s top line is roughly five-times larger than JCP’s. This outsized spend cannot continue and should not be required – with time, it must be tapered back to industry-comparable levels.

Infrastructure / CapEx – “We’re investing in our stores. The $810 million of capital that we invested last year went into a number of stores that hadn’t seen investment for a number of years; so yes we transformed 6 million square feet of shop space, but we also invested in lighting, in maintenance, in things that had been deferred for a number of years.” Hopefully there’s some additional color around this in the 10-K; dissecting the breakdown in CapEx spend would be helpful in assessing the viability of the transformation under multiple scenarios.

Winning Back Customers - “We’ve done a number of things inside the stores that have allowed us to attract a new customer, and in some cases, that’s been at the expense of our core, and we cannot allow that to happen…” Coupons and promotions are coming back, with the “$10 off $50” being offered through Sunday as a starting point; in addition, the company is bringing back some assortment in April that customers have been screamingly loudly for, namely certain St. John’s Bay products for women (“huge, huge miss when we edited that out”). I think the messaging around this must be loud and clear ("WE MESSED UP"); I'm hoping Sergio Zyman learned a lot with the "New Coke" disaster that he can apply here...

Sales – Our customers need the ability to go home “and state how much money they’ve saved... we hear our customers loud and clear.” Mr. Hannah said that they must compete “every week” – suggesting that sales will be coming back in a much bigger way then we’ve seen to date.

Vornado Sale – Mr. Hannah suggests that Mr. Roth has been as “supportive and constructive” as he’s ever been in board meetings, and suggested the sale may be due to changes at Vornado itself. Vornado’s CEO stepped down on February 27th, and Mr. Roth will step back into the role that he relinquished in 2009; Mr. Hannah suggests that JCP had simply become more trouble than it was worth (dominated Vornado’s conference call, despite the fact that the stake – on a mark to market basis - was less than 2% of VNO’s total assets at year end 2012). Personally, I’ve believed that this was a plausible explanation from the start; convincing me that Steve Roth would walk away from what he sees as a materially outsized risk-reward opportunity in order to appease Wall Street or spend less time on JCP as a whole (which could’ve been achieved by stepping down from the board without selling 40% of their stake) is a much harder sell…

Transformation – The speed of the transformation “is going to depend on how quickly we’re able to connect not only with the new, but with that core customer that we’ve somewhat alienated”, a nice way of saying that this transformation is dead in the water if JCP cannot get the core customer back in the store.

Home & Martha – “From a product stand point, we have several other brands in each of these categories that we have on order that are coming into our stores as part of our “Home” rollout. We certainly would love to be able to have all of Martha’s product in our stores as soon as possible, but at this point we’re going to assume that’s not going to be the case; we have been bringing in additional brands in those categories, and we’re very excited about the timing of our home rollout in May and what we’re seeing in the home industry and what we’re seeing with home sales, hoping we’re going to be able to piggyback on the timing of our new “Home” area opening up on May 5th.” It will be interesting to see how mediation plays out...

Q4 Shop Performance
– “We took the performance of that space in Q4, and using the exact same methodology that we used in Q3, the productivity was within a couple dollars – it was like a 1.6% or 1.8% difference in term of the sales productivity.” This is still small potatoes in the grand scheme of things, but critical in analyzing JCP; with comp sales off materially from Q3 to Q4, the shops held on quite nicely, and put up attractive numbers – in an atrocious traffic environment (off an additional 500 basis points sequentially). The productivity in these shops, which has been forgotten by the media in their focus on the failures of the pricing strategy, is representative of where JCP looks to head in the coming quarters.

I’m still waiting for the 10-K (should be published in the next two weeks), and will be closely monitoring the reversion to sales; once we get it I’ll have much more to say about JCP.

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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.

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