In case you haven't heard already, Soros Fund Management LLC scooped up about 17.4 million shares of J.C. Penney Company (NYSE:JCP) on April 15th. This essentially makes legendary fund manager, George Soros, the 4th largest holder of a company in the middle of a spectacular nosedive. Is he simply trying to prove that he's still alive, or is this another one of his shrewd contrarian investments?
What is more shocking is his hands-off approach to his investment. In a 13G SEC form filed on Thursday, April 25th, Soros indicated that he has no intention of shaking things up at the 111-year-old retailer. If the shares were bought on the open market at the price they were trading that day -- between $14 and $15 -- that's a $252 million investment. If I were a Soros Fund client I would be munching antacid tablets by the handful.
Let's compare J.C. Penney to similar department store chains Macy's (NYSE:M), Kohl's (NYSE:KSS) and Dillards (NYSE:DDS) to see just how ridiculous this trade appears. The yield figures below are based on April 25th closing prices.
Revenue Quarterly Year on Year Growth
Trailing Twelve Month Operating Margin
All three of J.C. Penney's competitors above are more or less after the same value-conscious demographic. As you can clearly see, an investment in Macy's, Kohl's or even Dillards makes more sense than J.C. Penney. Both Macy's and Dillards have experienced revenue growth of more than 7% year on year for the quarter ending January 31. All three competing department store companies boast operating margins that are second only to the more upscale Nordstrom (NYSE:JWN).
Not only are the three highlighted competitors above doing a great job of growing their businesses, but they're reasonably priced. With respect to closing prices on April 25, Kohl's looks almost cheap with an earnings yield -- the inverse of a price-to-earnings ratio -- of 8.7%, and a dividend yield of 2.87%.
When Ron Johnson took the reins from Myron "Mike" Ullman in November 2011, J.C. Penney's earnings were already fading like a cheap pair of jeans. As you can see in the chart above, with the exception of Dillards, 2012 was hardly a banner year for any of the above department stores.
Johnson's rollout of an anti-discount rebranding effort was, to put it mildly, a colossal failure. Even Martha Stewart couldn't run from J.C. Penney fast enough. During the quarter ended January 31, 2013, it looks like J.C. Penney's core customers also ran to Macy's ... and Dillards. The good news is that with Johnson out, and Ullman back in, J.C. Penney has a good chance of reconnecting with many of its estranged core customers. That's what I think the Soros fund is betting a quarter billion dollars on.
A classic "correctable error" opportunity
When an otherwise well run company makes an awful mistake, like alienating its core customers overnight, an extremely lucrative opportunity is created. Of course, the company needs to realize the mistake quickly and immediately take steps to reverse it. It appears that J.C. Penny did exactly that when it ousted Johnson and brought Ullman back.
Soros is famous for finding opportunity where others see doom. I'll bet his mouth started watering the moment he read that Ullman was returning.
Betting on a return to ... mediocrity
Ullman served as CEO of J.C. Penney from 2004 through 2012. As you can see, he was at the helm during the company's best years in a generation, at least in regards to earnings per share. Although earnings faded under his leadership during the last several years of his tenure, department store earnings are, of course, cyclical.
J.C. Penny Earnings Per Share Fiscal 1994-2013
At the time the Soros Fund bought into J.C. Penney the shares were trading at about 1.1 times the company's tangible book value. In order to double his investment, Soros doesn't need J.C. Penney to repeat the success of the 2006-2008 years, he just needs it to stop bleeding money and become moderately profitable again.
Expecting a repeat
As of the quarter ending January 2013, the company had tangible assets totaling about $9.8B. It still has stores in 49 states and Puerto Rico (If you know the state without a J.C. Penney, please comment. It's killing me). I wouldn't be surprised if the company went back to the deep discount loss leaders model that brought shoppers into stores and earned the company a modest but stable profit. I wouldn't even be surprised if it brings back the old logo.
You know, the more I think about this trade, the more upset I get for not thinking of it first.