J.C. Penney Company (NYSE:JCP) has been on a roller coaster ride since activist investor Bill Ackman became involved. The roller coaster ride reflects the high hopes investors had for Ron Johnson and his abysmal performance. J.C. Penney was at one point at the beginning of the year trading around $40 per share. Recently the stock hit a 52-week low of $15.69 and has rallied to a recent high of $21.46, an increase of over 35%.
J.C. Penney started this journey under new CEO Ron Johnson, Apple's (NASDAQ:AAPL) retail genius. He unveiled a new strategy to transform the stores into a collection of shops or stores within a store. I believe overall this was and still is a good idea. The shops format is most likely a better organizational method then the endless racks currently used in department stores. The problem lies with the implementation of the concept. In the implementation, management, specifically CEO Ron Johnson, failed. He did not test how consumers would react to the whole concept. Furthermore he abandoned promotional activities, sales and coupons in favor of his fair and square pricing strategy. This made it impossible to compete in the heavily promotional retail space. The effects of his strategy were quickly felt; sales dropped over 20% in the first quarters after the new strategy was implemented.
Recently J.C. Penney has started bringing back promotions. Sadly they are not doing it to the extent needed to revive the sales numbers. The promotions seem to be half way measures to boost sales and their effectiveness is yet to be seen. J.C. Penney is trying out unorthodox promotional strategies such as free kids haircuts and a Friends and Family 20% off coupon to lure customers back. The change to a semi-promotional strategy is simply too little too late in such a heavily promotional industry.
Regardless of the recent rally in the stock you should under no circumstances buy any shares. There have been no signs of improvement in sales and we could potentially see a 30% sales decline this quarter. J.C. Penney's current gross margins stand at 34.5%, much lower than competitors like Kohl's (NYSE:KSS) (38.2%) and Macy's (NYSE:M) (44.2%) . At these margins, J.C. Penney needs grow revenue by over 10% just to break even. Nothing about current progress even hints that this is feasible.
If current trends continue, J.C. Penney's solid balance sheet will erode. The company has $500 million in cash and short term investments and a $1.5 billion revolving credit facility. This will allow J.C Penney to continue its transformation during 2013. But if the situation doesn't improve after that J.C. Penney may have to resort to selling some of its vast real estate portfolio to raise cash.
The recent rally in the stock looks like a great exit point until things at J.C. Penney calm down. If the Company manages to raise operating margins from around negative 5% to 11% like Kohl's. A reasonable valuation (PE of 11) would raise J.C Penney's stock price to $40 a share. The upside potential of J.C. Penney is extremely alluring at these price levels. However, in my opinion it is better to stay on the sidelines until J.C Penney at least breaks even before initiating a position. If at any point before Q4 earnings the stock price goes above $25 a share, J.C. Penney would be a great short candidate.
Disclosure: I am long KSS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.