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J.C. Penney (NYSE:JCP) is a struggling company with blurred strategic horizons and increased loses. Strategic revamping by changing layouts has been the key strategy of J.C. Penney this year. The company has tried to develop mini stores within stores but the strategy has faced many issues because of a deviation from the core competitive advantage i.e. promotions and low pricing.

Q3 earnings have not been able to change our bearish stance that we took in our previous articles. We have been standing by our bearish stance mainly because of a partial failure that the company has faced in its restructuring efforts. The forecast of the CEO of bad financial results this year added weight to our belief. Quite interestingly, the results of the third quarter seem to agree with the forecasts.

Financial Overview

From an operational perspective, the company seems to be in deep trouble as its revenue is seeing a consistent decline. When compared to the third quarter of 2011, this year has seen a drop in total revenue by 26.6%, indicating a loss in market share. The cost of goods sold has also seen a drop of 20.9%. This clearly indicates some cost control issues that the company is facing as the gross margin has gone down to 33% from 37%, reflecting that cost has not fallen as much as revenue has. Net income has not recovered yet and is negative for this quarter as well. The sell side is expecting a rise in revenue in the future but we doubt that because of some recent failures in its restructuring activities. The following graph depicts these facts.

Source: Y Charts

Similar trends can be observed in its liquidity. The company has been witnessing a drop in its cash reserves YTD. The following graph clearly shows that.

Source: Y Charts

Given that the management is working on restructuring and re-strategizing, this declining cash balance and worsening profitability does not reflect well in its efforts. As the company is trying to restructure its designs, it might need cash in the future. Worsening profitability and declining cash balance can be a big hurdle. The company's deteriorating financials convince us not to give it a buy rating.

Valuation Analysis

JCP does not look attractive from an investment perspective. The price of the stock has gone down by 38% YTD. When analyzed more closely, CEO's lower forecast for the year was followed by a 14% drop in the price of the stock. The third quarter earnings release on the 9th of November, 2012, did not come as a shock as the company had foretold these losses. The following graph shows the loss in value after the news.

Analyzed relative to other companies, the stock is not attractive to investors.

The above table aims to highlight some of JCP's valuations relative to few other retailers. The forward P/E is 15.52X, which is higher than most of its competitors. The EV/EBITDA analysis also tells a story of overvaluation. While its competitors are trading at an average of 9.54X, JCP is trading at 20.38X, which show that JCP is overvalued as compared to its competitors.

Strategic Revamps

The financial side of the company appears quite negative and does not seem very encouraging for investors. Having realized that, the management has designed a new strategy to improve the situation and bring some of its old customers back to the store. The company seems to have realized that its outdated business model is no more the source of its key competitive advantage. "By far the largest part of our store is the old jcpenney, which continues to struggle and experience significant challenges as evidenced by our third quarter results," said Johnson.

As the old model struggles to be competitive, the management has come up with a new strategy of setting up stores within JCP. This new idea, termed as the "Store within a Store" strategy, is a strong hope for the company. "However, the new JCP, centered on the shop concept, is gaining traction with customers every day and is surpassing our own expectations in terms of sales productivity which continues to give us confidence in our long term business model."

Although the new strategy seems to have made the management bullish, many of the benefits it is bringing are being offset by other factors. The main factor has been customer dissatisfaction. The company has been eliminating coupons and discounts. This factor has made many customers switch to competitors. Currently, the implementation of the new strategy cannot be equated with success as it is witnessing many difficulties.

Johnson has acknowledged that the job is more challenging than he expected. He attributes the drop in sales to an intended strategy and aims to return to growth next year. "Job No. 1 is to return to growth next year. Let's make no mistake about it. This is a year where we said we are willing to let the sales drop to establish a new base for the new JCP," he said Friday. "We have to return to growth."

Our Stance

Form a financial perspective, the company is not attractive to investors. The company has been facing loses and is trading at a very high P/E and EV/EBITDA, showing that the stock is overvalued. The new concept of Boutiques at the stores has posed many challenges as the company has annoyed many customers. This has made sales drop and customer loyalty to shift.

Although the company plans to focus on growth next year, we suggest a bearish stance until the efforts for the new mission start yielding benefits. We don't expect the stock to move up much and therefore have a sell rating.

Source: Down In Its Own Rubble; The Sorry State Of J.C. Penney