We have been following J.C. Penney Company Inc. (JCP) off and on since 2011 because Bill Ackman had taken a position in JCP and because Ackman was influential in recruiting Ron Johnson away from Apple Retail (AAPL) in order to become JCP's new CEO to succeed Myron Ullman, who was JCP's CEO from 2004-2011. Although we demurred from taking a stake in JCP, we were intrigued by the idea of JCP's willingness to "shake things up" as its EPS peaked in FY 2008 and declined by 68% during the following three years. We were surprised that Ron Johnson's first year as CEO of JCP was quite frankly an utter disasterpiece. Based on JCP's performance in its most recent quarter, we can see that it was not a December to Remember for JCP and why Vornado (VNO) sold 10M of its 23.4M stake in JCP.
Source: Morningstar Direct
JCP's recent performance in its fourth quarter was absolutely atrocious! Ron Johnson's first quarter as CEO of JCP was the fourth quarter of its 2012 Fiscal Year and JCP's performance was uninspiring. JCP's total sales declined by 4.9% due to the following three factors: The exit of its catalog and catalog outlet business, a 3.1% decline in its online sales activity and a 1.8% decline in comparable store sales. Johnson introduced his new Fair and Square pricing strategy as well his plans to overhaul the stores into a collection of small shops selling popular brands that make the stores feel like outdoor mini malls during the first quarter of the 2013 Fiscal Year. Unfortunately, JCP's comparable sales dropped significantly in Q1 2013 (-18.9%) and the decline has been exacerbated throughout the remainder of FY 2013. We would think that JCP's sales can't get any worse for FY 2014 after suffering through the long slog of a 25% decline in its comparable store sales in FY 2013.
We are stunned at how poorly JCP has performed since Ron Johnson's arrival. We have seen a number of notable investors in J.C. Penney's shares and bonds because they were expecting Mr.Johnson to reinvent JCP because of his solid record of performance with Target and his outstanding track record with Apple Retail. The following notable individuals and institutions own JCP's stocks and bonds:
- Bill Ackman's Pershing Square Capital (39M shares representing 17.8% of JCP's stock)
- Steven Roth's Vornado Realty Trust (23.4M shares representing 10.8% of JCP's outstanding shares)
- Dodge & Cox (20.2M shares representing 9.3% of JCP's stock)
- Evercore (11.95M shares representing 5.5% of JCP's shares)
- Fidelity Investments (15.8M shares representing 7.19% of JCP's stock)
- Wellington Management Company (14M shares representing 6.36% of JCP's stock)
- Hotchkis & Wiley Capital (13.9M shares representing 6.32% of JCP's stock
- Glenview Capital (7.3M shares representing 3.3% of JCP's stock)
- Daniel Fuss of Loomis Sayles has $134.5M worth of JCP's bonds in three active fixed income funds that he and his team manage and we estimate he had a similar amount in his SMA and institutional account mandates as well.
- The J.C. Penney Savings, Profit-Sharing and Employee Stock Ownership Plan also has 13.8M shares representing 6.3% of JCP's outstanding shares
Notable recent reductions in JCP share holdings came from Vornado (10M shares sold on March 4th 2013) and Maverick Capital (sold off its 9M share position in Q4 2012). Notable Q4 2012 additions came from Wellington (11M), Hotchkis & Wiley (4.9M) and Glenview (2.8M).
Not only did JCP see its revenues fall, but its gross margin saw a major decline in terms of dollars and percentage. JCP's gross margin dollars declined by 43.6% in Q4 2013 and 34.6% for FY 2013, which is a relatively severe decline and a serious cause for concern. Although JCP's operating expenses declined by 11.8% in FY 2013, it was not enough to offset the sagging gross margins that JCP endured in 2013.
JCP has seen its sales drop by over 20% in all four of FY 2013's fiscal quarterly periods and it ended seeing its FY 2013 sales decline by 24.8% versus FY 2012 while racking up $985M in net losses during the YTD 2013 period. Although JCP's SG&A expenses declined by 11.8% in FY 2013, this was not enough to forestall this massive loss. JCP burned through $303M in cash during FY 2013 even with the aid of $526M in cash harvested from the sale of non-operating real estate assets. JCP's loss would have been greater if it did not enjoy the benefit of $412M in income and gains from the following non-operating real estate assets:
- $200M from redemption of Simon Property Group (SPG) REIT units
- $15M from the sale of its CBL & Associates Properties (CBL) REIT shares
- $28M from the sale of leveraged lease assets
- $151M from the sale of joint venture investments
- $3M from the sale of a building from its former drugstore operations and
- $15M in income from joint ventures and REITs held
Barron's magazine was skeptical about Johnson's new strategy as far back as January 2012 and J.C. Penney's shareholders have suffered through the indignity of a negative 48% total return and the suspension of its dividend. Macquarie analyst Liz Dunn made an interesting point about how JCP was seeing the slow decline of sagging stagnation relative to its peers and that a new model needed to be tried, however, the new system has generated deep losses within its first year. UBS recently decided to add insult to injury by cutting its rating on JCP to sell and slashed its price target from $21/share to $13/share. We can see why UBS is losing confidence in Johnson as he had to reintroduce discounting and his handpicked President Michael Francis left the company.
According to a recent Bloomberg interview with JCP's CFO Ken Hannah, the company expects to reverse its rotten FY2013 performance by expanding private-label lines such as St. John's Bay and reviving promotions. JCP has a long way to go in order to recover the sales that it lost in its most recent fiscal year. If we were to compare JCP to Target (TGT), Macy's (M) and even Kohl's (KSS), we can see that those stores were able to enjoy steady sales growth in each firm's most recent quarterly period. Macy's enjoyed 7.2% sales growth in its most recent quarter while Target checked in with 7% sales growth and Kohl's racked up 5.4% sales growth.
Source: Morningstar Direct
In conclusion we will be expanding our formal coverage of J.C. Penney. We are intrigued with the high level of capital conviction as the 17 largest shareholders own nearly 90% of JCP's outstanding shares. JCP is not a company we would not have ordinarily pursued due to its underwhelming brand name, shopping experience and financial performance. We can see that we saw the same mediocre management that Bill Ackman referred to in his presentation at the Ira Sohn conference. We liked that at the very least, it owned 49% of its retail square footage footprint and if JCP fails at its grand new strategy, it can monetize the real estate owned in order to salvage value for shareholders. While we are impressed by Ron Johnson's record of results as a merchandising executive with Target and as the father of Apple Retail, it remains to be seen if he can be as successful with J.C. Penney as he was in his previous roles.
Disclosure: I am long AAPL.
Additional disclosure: This article was written by an analyst at Saibus Research. Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this article. We have no business relationship with any company whose stock is mentioned in this article. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.