Why I Bought J.C. Penney: A Speculative Play With Upside

| About: J.C. Penney (JCP)

The Ron Johnson troubled tenure as CEO at J.C. Penney (NYSE:JCP) has come to an end. Poor operating results likely played a part in his exit. Sales fell 25% in the year ending February 2, 2013, depriving the company of $4.3 billion in revenue, cash desperately needed to fund its turn-around.

The story of Johnson's attempt to revitalize J.C. Penney has been well covered. Whether he ran out of time or embarked on a path with the wrong strategy isn't material to this article. Suffice it to say Johnson, who built his reputation reinventing retail at Apple (NASDAQ:AAPL), changed the product mix and pricing strategy at J.C. Penney, eliminated price mark-downs and causing the bargain hunting J.C. Penney chief shopper to abandon the store. As the retailer struggled with dramatically reduced floor traffic, he reintroduced promotions and sales prices, but it was too late. His marketing message was all over the map, from highlighting free haircuts for kids to comparison pricing. Speaking with analysts in February Johnson said the company had "made some big mistakes, and I take personal responsibility for these." J.C. Penney's marketing, he said, "didn't connect very well with our customers."

Penney's has brought back former CEO Mike Ullman to lead the company. Ullman served as CEO immediately prior to Johnson and his return has been met with mixed results from the investing company. Most of the Johnson team has left and Ullman is rehiring some of the former executives who were forced out under Johnson.

No doubt about it, there are a lot of real problems facing J.C. Penney going forward. First, the company must find a way to bring back former loyal shoppers and reintroduce them to the store and the current product mix while CEO Ullman meets with suppliers to bring back some of the mainstay products Penney was known for but were eliminated under Johnson. Just as critical, the company is facing a cash crunch and taking steps to address it, including the April 24, 2013, filing of a shelf registration with the SEC saying it may sell a combination of equity and debt securities. The company's adjusted free cash flow fell to a negative $906 million last year from a positive $23 million in 2011 and $158 million in 2010. Its long-term debt, including capital leases, notes payable and current maturities, now totals almost $3 billion. Other issues include finding and hiring executive talent, rebuilding morale at the store and sales counter level and creating and executing a marketing plan that resonates.

In fairness to Johnson, some of the changes he made were positive and likely critical to the long-term survival of the company. I can't speak about all 1,104 stores, but at my local mall, the J.C. Penney store looks great. I especially noticed how bright the store is. It isn't dark and dowdy like it was before the Johnson era. Displays and signage are revitalized and relevant. The boutique store concept looked inviting with bright splashes of color and merchandise piled high. The introduction of Joe Fresh at my local store was particularly inspiring. Joe Fresh is a partnership between J.C. Penney and the Canadian fashion brand of the same name (Joe Fresh) which has rolled out in 681 J.C.Penney stores across the country. Joe Fresh is a lifestyle brand targeted at younger consumers with a coordinated product line with everything from $4 flip flops to $39 silk shirts. Nothing in the line is priced at over $69.

Speculative Investment Thesis

The stock was priced in the low $40s as recently as January 2012. It closed on April 25, 2013 at $15.24. The most recent quarter financial results represent six consecutive quarters reporting a loss. The company lost $980 million in FY2012, the stock is down 56% over the past 52 weeks, and had a negative 27% return on equity in 2012. Combine all this with Increased competition from Macy's (NYSE:M), TJ Max, Kohl's (NYSE:KSS) and others, and it is just an overwhelming amount of negative - but I believe it is all baked into the stock price.

The new (and former) CEO Ullman "simply" has to do the things an experienced retailer must do: Advertise. Create Promotions. Bring back sales. Bring back the product and the traditional JCP shopper while appealing to the younger consumer with boutiques like Joe Fresh. One might say "you can't be all things to all people" ... but isn't that what a mass-merchandiser must be to find success? Because of lowered expectations from Penney and easier comps going forward due to the fall off in sales over the past year, even modest success will make J.C. Penney a profitable investment at today's prices. Could the stock double to $30 by back to school? Could the stock move into the mid $30s during a successful holiday season in the 4th quarter? Both seem like reasonable targets to me.

George Soros Jumps into J.C. Penney: A vote of confidence

After hours on April 25, 2013 it was revealed that George Soros has taken a 7.9% position in the company, accumulating 17 million shares of Penney. The 13-G filing was dated April 15, 2013. With investors like Soros as well as activist investor Bill Ackman (JCP's largest investor) behind the company, it sure helps give confidence for small investors like me. Further, the Soros investment is seen as a vote of confidence for returning CEO Ullman and the steps he will likely take to right the ship at J.C. Penney.

A balanced look: Upgrades and Downgrades:

One analyst downgraded the stock saying J. C. Penney is too expensive and not a turnaround play. On April 23, 2013 Maxim announced a sell rating on the stock and $10 price target.

Meanwhile on April 22, 2013 Gifford Securities analyst Bernard Sosnick, a 30-year industry analyst, raised his recommendation on the company from neutral to buy. Sosnick said the company "is at an inflection point, moving from danger to a more secure foundation to build upon," adding it's likely the stock could appreciate to $20 to $25 a share on a "reflex rally."

Conclusion….this speculative play isn't for everyone!

Perhaps you are an investor like me ... conservative and careful to build a portfolio of dividend growth stocks ... made up of tickers known for their penchant forever-increasing dividend payouts. This is the kind of portfolio I envisioned would provide for a secure and happy retirement. And it's all working out just like planed. But maybe you are also like me in that you have a small portion of your cash set aside to make speculative plays, those that have a high likelihood of working out. It is with this in mind that I tell the story that I find compelling about today's J.C. Penney.

Disclosure: I am long JCP. 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.

Additional disclosure: I am not a professional investment advisor, just an individual handling his own account with his own money. You should do your own due diligence before investing your own funds. This article represents a speculative play and is not for everyone.