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A comment in the last article I wrote on preferred stocks was;" The fundamentals of the common stocks underlying (the list of preferred stocks I wrote about) range all over the place. How important are these factors to you regarding decisions to own any of the preferred (stocks in your list)?" The words enclosed were inserted to clarify what the person was asking. This raises an important question about choosing to invest in a preferred stock. To answer this question, I decided to take several preferred stocks offered by J.C. Penney (NYSE:JCP) and go through the decision-making process. The three preferred stocks are PFH, KTP, and HJV.

First looks at these preferred stocks make them look very interesting to the income investor. Look at the chart below: (Data take from QuantomOnline.com)

Preferred Stock Symbol

Coupon Rate

at Offer Price

Cusip

PFH

7.63%

126797208

KTP

7.63%

220803100

HJV

7.00%

80412E202

These preferred stocks are structured products. They are debentures that have been sliced and diced to attract the individual investor. Debentures are normally sold like bonds in $1000 increments. A third party such as a bank has taken these J.C. Penney debentures and split them into $25.00 increments in order to sell them.

The following chart below shows the selling price of these preferred stocks as of 10/18/2013 and the actual rate of return based upon the current selling price.

Preferred Stock Symbol

Current Selling Price

Rate at Current Price

Moody Rating

S&P Rating

PFH

$14.90

12.75%

Caa2

CCC-

KTP

$14.95

12.70%

WR

CCC-

HJV

$14.40

12.15%

Caa2

CCC-

Wow! Look at the current rate of return on these preferred stocks. They appear to offer quite a bonanza. This fact alone should raise the question, "What are the reasons for these very high returns?"

The first step is to take a look at J.C. Penney, the company that pays the interest that supports these preferred stocks. Looking at the financials of the company, JCP lost $7.32 per share over the trailing 12 months period. Quarterly revenues were down nearly 12% year over year. Shares of the company have dropped nearly 75% over the past year. Nearly 55% of the shares outstanding are sold short indicating that many investors think the company's shares will fall further. Ten million shares have been sold by insiders over the past 6 months which indicates that insiders are losing confidence in the company as well.

The next step is to look at what analysts have to say about the company. S&P's outlook on JCP is not nearly as negative as the previous paragraph would lead one to believe. JCP had hired former CEO Ron Johnson in November 2011 to revitalize the retail company. His execution as CEO was described as "one of the most aggressively unsuccessful tenures in retail history." On April 8, 2013 he was fired as the CEO and replaced by Mike Ullman, the former CEO. So the board of JCP removed Ullman, replaced him with Johnson, removed Johnson and brought Ullman back to run the company.

S&P views the return of Mike Ullman as a positive for the company. Ullman has returned JCP to a promotional pricing strategy and the reintroduction of popular private labels that were dropped under Johnson's leadership.

S&P sees JCP maintaining adequate liquidity to run its business as a consequence of the $785 million dollar cash infusion from its recent share offering along with the reduction in expenses as a consequence of restructuring. It envisions JCP reconnecting with its core customers along with its new promotional strategy online and in stores driving higher sales over the next few quarters. There is pressure on its gross profit margin since it must sell old inventory at marked down prices. S&P predicts a loss of $5.50 per share for fiscal 2014 and a loss of $2.50 for fiscal year 2015. Credit Suisse predicts a loss of $6.33 per share for 2014 and a loss of $1.79 per share in 2015.

The next step is to consider the viability of the industry. JCP operates as a department store with an online presence. This means that JCP operates in a very competitive industry. There is a multitude of retailers that offer many of the same products that JCP sells. However the company retails things everyone needs so there is a huge and growing market for those items. There are also some initiatives in the works that may drive consumer interest and sales. Disney (DIS) announced plans recently to launch 565 store-within-a-store concepts in JCP. Penney also announced that it will be open Thanksgiving and will bring back its snow globe giveaway. There is the possibility that the recent return to promotions along with these new initiatives will give Penney a competitive edge for the upcoming holiday season. However all retail stores face a shorter holiday selling season this year compared to last which will likely hurt year over year comparisons. Can JCP compete against the likes of Amazon.Com (NASDAQ:AMZN), Bed, Bath and Beyond (NASDAQ:BBBY) and Kohl's (NYSE:KSS)? This Christmas Season may give this question some strong indications.

This leads to the final question the investor must tackle, "Will the company survive and be able to pay the dividends called for by the preferred stock?" The elements considered above should provide one with clues to answer this question. Looking at the pros and cons of the future viability of JCP, the company appears to be on a precipice of a turnaround or going further into the hole. There are too many uncertainties to give a clear answer with any confidence. First there are the questionable decisions made by the board of directors. Second there is a CEO who was removed for doing a poor job and then rehired to fix the company. If Mike Ullman was not satisfactory earlier, what has happened to make him the choice to reverse the downward trend of JCP going forward? Third there is need for capital to see the company through this series of bad decisions. Does the company have the liquidity to navigate this trough to allow it time to achieve profitability? Since there is no clear answer when JCP will again regain profitability, one must bet that it will accomplish this goal within 2 years if one were to buy these preferred shares. While the company has enough cash on hand to see it through 2 years of losses, if there is a downturn in the economy or poor execution by management, JCP does not have enough capital to survive an additional year of losses. Therefore buying these preferred stocks looks like a bad bet. This appears to be a company on a downward spiral grasping at straws attempting to stay alive not unlike the historical retailers of old such as Montgomery Ward and Woolworth. I would avoid these preferred shares even though they would grant one a great return if the company were to manage a turnaround.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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.

Source: Analysis Of J.C. Penney Preferred Stocks: An Answer To A Reader's Question