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What to Make of J.C. Penney (JCP)?

March 18, 2013 | About:
Be sure to check out our detailed stock analysis (click here). ​Time appears to be running short for current J.C. Penney (JCP) CEO Ron Johnson, possibly as short as 10 months. Recent reports reveal concerns that the retailer's board of directors is restless and may only give Johnson until the end of 2013 to right the J.C. Penney ship. But is Penney even a good long-term investment?

Johnson was a former Apple senior vice president, having been in charge of strategy for the tech giant's retail stores, before joining Penney in November 2011. He has launched various initiatives in an attempt to revamp the struggling retailer. Still, investors have refused to put their full faith in any of his plans, with the stock down over 60% in the last 12 months.

Part of the big drop as of late includes the company's reported 32% decline in same-store sales during the fourth quarter. This pushed earnings to a loss of $1.95 per share, well below the consensus of a $0.24 per share loss. This signals that Penney's turnaround is taking a bit longer than expected. CEO Johnson has been faulted for his choices, and the recent quarterly results have led to back-peddling on his part. This includes the misstep on sales campaigns. The retailer now plans to have sales each week.

Smart Money Moves

Billionaire Bill Ackman, and his Pershing Square Capital hedge fund, is Penney's largest shareholder, owning some 18% of the retailer, or 39.1 million shares (see Ackman's profile). This is the same Ackman who has taken a lot of heat as of late given his public battle with Carl Icahn over Herbalife. Even a Vanity Fair profile has taken aim at Ackman, with a quote from Robert Chapman of Chapman Capital that notes...“Bill Ackman has been so arrogant and disrespectful to so many people, presumably on the theory that he would never be in a position where these subjects of his disrespect could actually act on their deserved hatred for him. But now, with J.C. Penney and Herbalife going against Ackman, his ‘stock’ has moved down."

Vornado Realty Trust, previously Penney's second largest shareholder, recently sold off some 10 million shares or around 40% of its stake. Vornado is one of the largest mangers of commercial real estate in the U.S. and appears to have lost confidence in Johnson and the retailer's ability to turnaround. However, the REIT did hold on to 13.4 million shares, or 6.1% of Penney. Vornado lost nearly a quarter-billion dollars on its Penney investment, but the REIT has given no inclination as to whether it will sell off its remaining stake (check out all the hedge funds owning J.C. Penney).

The Retail Industry

The International Council of Shopping Centers reported that total retail sales were up 4.5% in January on a year-over-year basis, a positive sign for the retail industry (see which retailers outperformed). This is a tailwind for Penney and other major retailers, including Macy's (M) and Kohl's (KSS). Macy's managed to post its eleventh straight quarter of sequential earnings growth, this despite a tough economic backdrop, in part thanks to the fact that it is tailored to the higher-income customer, which extends to its Bloomingdale's chain. Kohl's saw December comp store sales up year over year, though they remained below the company's expectations. A big hindrance for Kohl's is its lack of an international presence, which results in overexposure to the U.S. market. Discounted pricing by Kohl’s has not allowed the chain to overcome the tough economic times either. Kohl's is finding itself undercut by the likes of T.J. Maxx with regards to pricing.

In recent news, Macy's is suing Penney over the 2011 partnership where Penney agreed to open Martha Stewart mini shops in its stores. Macy's also had a deal with Martha Stewart and said this of Penney's deal: "J.C. Penney wanted to rob Macy's of market share and destroy the competitive advantage that it enjoys as a result of its existing exclusive agreement with Martha Stewart."

Let's look at some numbers.

Compared to major retail peers, J.C. Penney is the cheapest.

Price to Sales

  • J.C. Penney 0.3
  • Kohl's 0.6
  • Macy's 0.6
But of course this is likely for good reason; just look at how the company has managed to destroy cash flow and shrink its recent return on investment:

5-Year Cash Flow Growth (historical)

  • J.C. Penney -22%
  • Kohl's 3%
  • Macy's 2%
Return on Investment (5-year average)

  • J.C. Penney -1%
  • Kohl's 10%
  • Macy's 1%
However, despite the beating the stock has taken it is expected to grow earnings nicely over the next few years, beating out major peers.

5-Year Expected Earnings Growth

  • J.C. Penney 30%
  • Kohl's 6%
  • Macy's 13%
I still remain cautious about this growth; since Penney is basically starting from nothing, its 30% annual EPS growth will still leave the retailer's EPS below its 2008 levels.

What's more is that assuming the 30% EPS growth that Wall Street expects comes true, Penney's EPS in 2018 will still be less than half of what it was in 2011.

So is the turnaround retailer worth investing in?

Analysts' price targets suggest there is little upside to Penney in the interim. The average Wall Street price target is $15.47, suggesting upside of only 4% over the next 12 months. Not only is the upside minimal, but there is still a large amount of execution risk at play.

Some of the compelling turnaround initiatives for Penney include a revamping of its point-of-sale technologies, in-store Sephora departments and a move from mall locations to newly built, standalone stores in off-mall formats. These are just a few, but it will be beyond 2013 before any of these start to produce a positive return on investment. So Johnson's plans to revamp the retailer's "look" into a more tech-iconic atmosphere, like that of Apple's retail stores, could well take longer than a year, yet major investors and board members might not give Johnson the necessary time. As a result, I remain cautious on the stock.

About the author:

Investment adviser and startup striver.

Visit mdhargrave's Website

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