J.C. Penney's Secondary Offering Bought Some Time, But Not Much

| About: J.C. Penney (JCP)

Immediately after J.C. Penney (NYSE:JCP) released its second quarter results I wrote an article in which I argue that J.C. Penney will either go bankrupt or substantially dilute shareholders in an attempt to stave off bankruptcy. That was on August 21st when the stock traded between $13.28 - $13.95. I was proven right when the company announced that it would issue 84 million shares 2 weeks ago.

The fact that dilution occurred so soon after I wrote this article flies in the face of management's expressed confidence in the company's financial position. As my previously cited article argues:

Management refuses to acknowledge what is so apparent to myself as well as several bond and preferred stock holders--viz., the company is in serious financial trouble. CFO Ken Hannah opens his part of the conference call by saying:

"Our results reflect the progress we are making on our journey to fix the problems we face and stabilize the business."

Whether Hannah is trying to keep up appearances or whether he is unable to draw conclusions from basic data, the company is in serious financial trouble, and management refuses to acknowledge it.

While in the past I have questioned management's oversight of the company's pending financial calamity I never could have dreamed that it would be so far off base that we would see a huge secondary offering so soon at a share price in the single digits. The punitive nature of this measure to existing shareholders speaks to management's desperation and the company's lack of capital despite claims that have been made by management--particularly by Mike Ullman and Ken Hannah--that there is a recovery, or that it has enough capital.

J.C. Penney is still heading towards bankruptcy, or a much larger secondary offering. The $800 million capital raise has merely pushed this point into the future, and not by very much--as I suggest below only by a few months, if that. If we look at the company's capital situation at the end of the second quarter (8/3/2013) and incorporate recent developments--most notably the company's capital raise, but also the 4% year over year drop in September sales and anticipated consumer pessimism caused by the government shutdown--this point becomes clear.

J.C. Penney's Financial Situation

Ken Hannah makes a statement in the company's second quarter conference call that implies that he believed that the company was financially stable as recently as August 3.

The financial actions we took in the quarter enabled us to stabilize the business financially and provide us with the necessary resources to complete the turnaround. Given the Company's current cash position, along with the undrawn portion of our credit facility, we expect to end the year with an excess of $1.5 billion in liquidity.

There are two material differences separating the company 9 weeks ago and the company today. First, Fox News is reporting that the company will have $1.3 billion at the end of the year, not $1.5 billion. Second, the first claim is simply wrong--why else would the company issue so much stock at a 13 year low for the share price?

Regarding the first point, what the company is essentially stating is that it plans on burning through an additional $40 million in cash per month for the remainder of the year than it initially thought. Seeing that the company has gone through about $130 million monthly over the past year this is a huge reduction in its liquidity estimate. Thus, if we assume the status quo, J.C. Penney is positioned to burn through $170 million monthly, which means that management bought the company less than five months with the secondary offering.

But my assumption of a flat cash burn rate is overly optimistic. The company has failed to demonstrate that it can turn its sales around, despite persistent vacuous references to a non-existent "turnaround." The weakness of middle class consumers, as evidenced by general weakness in middle class retailers (which I discuss in the aforementioned J.C. Penney article), is further evidence to this point. Finally general pessimism and job losses due to the government shutdown can do nothing to improve this situation. If the company's estimated cash burn rate can shoot up from just $130 million/month to $170 million/month in just a matter of weeks then there is no telling the deleterious impact that the retail environment can have on the company in the coming months.

Conclusion

J.C. Penney's secondary offering is simply not enough to buy the company the time it needs to turn its fortunes around. Even if the company can improve its situation to the point where it is no longer deteriorating the company will need more capital in a few months.

Furthermore, this offering solidifies the inconsistency between what the company has been saying about its finances and reality. Such inconsistencies almost always exist as managements are inclined to be overly optimistic regarding their companies' fortunes, but in the case of J.C. Penney it is especially acute. The fact that the company decided to dilute shareholders by 84 million shares while the stock was trading at levels not seen in 13 years proves that the company is not financially stable despite direct statements to the contrary.

With these points in mind I would still advise investors to avoid holding J.C. Penney shares, and I still think that more aggressive traders and investors should consider shorting the stock on a price spike.

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in JCP over the next 72 hours. 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.