Is J.C. Penney Beyond Help?

May.18.13 | About: J.C. Penney (JCP)

Another quarter is left behind and J.C. Penney (NYSE:JCP) continues to bleed cash like there is no tomorrow. The company's latest quarter didn't paint a pretty picture either. As time is ticking out, the company's options are narrowing. Can the company be saved?

The last quarter's results indicate that Ron Johnson's ideas were not good enough to help the company. The company reported a loss of $1.58 per share; excluding one-time items, the loss was $1.31 per share. The analysts were expecting the company to report a loss of 96 cents per share. To make the matters worse, the company reported a revenue decline of 16% (the analysts were expecting a drop of 15%) in addition to falling margins, as the gross margin fell from 37.6% to 31.3% since last year. The current margins represent the lowest margins in the last 10 years for J.C. Penney. There are so many things going wrong with the company, it will take a lot of work and time to turn it around.

This was the sixth quarter in a row where the company announced a double digit revenue decline. The company's new CEO Mike (also known as Myron) Ullman promised to return the company's profitability to 2011 levels when he used to run the company. He plans to attract more customers by offering discount coupons and a variety of deals. While Mr. Ullman's approach may seem overly simplistic, this doesn't bother me, because many times the simplest answer can be the best answer.

According to New York Post, Bill Ackman doesn't believe that Mr. Ullman has what it takes to become the permanent CEO of the company. It seems like Mr. Ackman sees Mr. Ullman as a temporary solution and he wants to company to search for his replacement already. On the other hand, the board of directors is fully behind Mr. Ullman. The former CEO Ron Johnson was recruited from Apple (NASDAQ:AAPL) by Bill Ackman, but later on Mr. Ackman became one of his strongest critics. Last month, Mr. Ackman called Mr. Johnson's management of the company "something very close to a disaster." Until recently, Mr. Ackman had so much influence over J.C. Penney's board of directors (as he's the largest single shareholder of the company); however, he might be losing some of this influence now.

The previous Ron Johnson tried to create an Apple out of J.C. Penney by canceling out all the discounts and clearance deals and bringing in more expensive brands in order to attract wealthier customers who are looking for quality regardless of price. The plan failed miserably because J.C. Penney continued to attract middle income consumers, who would walk in the store, leave without buying anything and go to Macy's (NYSE:M) across the street to find better deals. J.C. Penney was unable to attract wealthier customers from stores like Nordstrom (NYSE:JWN).

Many investors were relieved when Goldman Sachs agreed to lend the company $1.75 billion in order to create a cushion against running out of cash. On the other hand, this could be the company's last chance. In the last year alone, J.C. Penney burned through $1 billion of cash. The money that was borrowed from Goldman Sachs may not last for long if the company doesn't change things around quickly.

Mr. Ullman will attempt to run as many promotions as possible in order to attract price-sensitive customers who stopped shopping at J.C. Penney during Mr. Johnson's reign. Many clothing stores run between 20-30 promotions per year, including but not limited to Mother's day promotions, Christmas promotions, 4th of July promotions, Black Friday promotions and so on. A significant portion of shopping is done during these promotions and J.C. Penney lost a lot of customers by canceling out many of these promotions during the leadership of Mr. Johnson.

The company's e-commerce website suffered the same results its stores did. While most online retailers (such as Amazon's clothing department and e-commerce of Macy's) reported double-digit sales growth annually in the last couple years, J.C. Penney's website suffered double-digit sales declines year over year and left a lot of money at the table.

Currently, the analysts are not very optimistic about the company's future. For example, for the next quarter, analysts expect the company to report a loss of 88 cents per share where the expectations range from a loss of 52 cents per share and a loss of $1.52 per share. For the full year, even the most optimistic analyst expects the company to post a loss of $2.26 per share, whereas the most pessimistic expectation is as low as -$4.79. Again, even the most optimistic analysts don't expect the company to report a profit at least until 2016. Keep in mind that these expectations were posted before the company announced its quarterly result, and the analysts are very likely to downgrade their expectations even further.

In the short term, as the company offers discounts, promotions and offers, its margins are likely to decline further; however, its sales volume is likely to increase. If the sales volume can increase faster than margins decline, there is hope for J.C. Penney. During the earnings call, Mr. Ullman sounded very optimistic and confident (then again, you can say that the last CEO sounded very optimistic and confident too, which is a valid point). Mr. Ullman knows the company and the industry very well. He knows what shareholders want, he knows what the customers want and he probably knows how to turn the company around too. On the other hand, knowing and being able to execute are different things. Will Mr. Ullman be able to execute his plan for a successful turnaround? This is very possible, but given all the obstacles J.C. Penney has been facing, his chance of success will be around 50%. To answer the question in the title, J.C. Penney is not beyond help yet, but it has only one more chance, and if it misses this one, it may put itself in a situation where it's beyond help.

At this point, I am not too comfortable with investing in this company either as a long or as a short. I'd like to see some results first.

Disclosure: I am long AAPL. 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.