J.C. Penney (JCP) has certainly had a rough 2013, with many rating agencies considering JCP to be a poor investment, and for the most part not a 'buy'. There have also been a number of Seeking Alpha articles over the last several months, attempting to figure out the correct valuation methodology for JCP. I find the different valuation approaches interesting. But my investment in JCP, from several months back, relied on one alternative metric that has yet to be spoken of here at Seeking Alpha. It is this alternative metric, in addition to several other items, that make JCP a good buy.
1. P/E Ratio - The P/E for JCP is non-existent due to negative quarters that keep on going. This is certainly not a good reason to 'buy' JCP, but if we adjust the P/E Ratio we might be able to unlock some hidden value. See the below chart for the last 12 months of negative earnings:
We can see from the chart that there was a recent upwards trend as losses decreased. However despite this, JCP has not seen a positive quarter since July in 2011.
So, as indicated earlier the classic Twelve-Month-Trailing Earnings P/E Ratio can not be used as a result of the negative earnings. I have therefore taken a somewhat different approach with respect to JCP and the P/E Ratio. I have decided here to analyze JCP by taking into account the Cyclically Adjusted P/E, where 10 years of EPS data is included in the calculation for the denominator.
In other words, we have the following for P/E:
For JCP this gives us about 4.31 which one can also see by going to the CAPE Ratio Calculator.
How does this help us? Well, it helps us realize that with respect to the overall trend of earnings for JCP during the last ten years, that it is probably an undervalued stock at the current price. Since we can view this alternative P/E in a similar manner as the regular P/E, we can see that a 4.31 value is very good. We must simply be assured that there has been some instrumental change at JC Penney that will ensure future positive results with respect to earnings in order to be sure that an investment might be wise. I will cover this later under the Qualitative Factors component.
2. P/B Ratio - The P/B Ratio is a critical ratio as it provides us with a snapshot view of the dollar for dollar value of our potential investment. In this case it is roughly one dollar for one dollar as seen by the P/B Ratio being at 1.006. This means, that if JCP were to go bankrupt tomorrow, an investor would receive roughly the same money back that was already invested (excluding fees).
This is a very good P/B Ratio for the sector that JCP is in as is shown by a fellow Seeking Alpha contributor. To summarize what this article says I have included the important part here:
Price-to-Book (P/B) Ratio (Current Through Q3 2013):
JCP = 2.77B / 2.64B = 1.05X
M = 19.61B / 5.44B = 3.60X
KSS = 12.13B / 5.92B = 2.05X
DDS = 4.23B / 1.87B = 2.26X
So, as we can see JCP is undervalued with respect to the P/B Ratio as well as our alternative P/E Ratio (as shown above). This prompted the recent Forbes posting which you can see right here.
3. Qualitative Factors - There are many qualitative factors with respect to JCP. There is also a lot of noise; the SEC investigation prompted by the issuance of new shares several months ago is one such factor that has simply clouded the JCP picture but probably does not significantly effect its value. Some of these non-issue items that merely contributed to 'noise' for this stock, were positive such as the same store increase in sales for the month of November, while some were negative such as the delisting from the S&P 500.
But, what I think really contributes value to JCP is the reinstatement of Ullman as CEO. I would count the change from Ron Johnson as being a very significant improvement and one of the chief reasons why I invested in JCP. Ullman brought success to JCP during his earlier tenure and we can only assume he will do the same once again.
Ron Johnson was not the right choice for JCP. Retail is not rocket science; but rather, depends on the right things being done correctly on a consistent basis. Ullman understands this. Some of these factors are as follows:
A. Properly priced merchandise for your consumer base.
B. Good use of space (square footage) within the retail environment and solid turnover of product with adequate supply.
C. Some sort of good discount incentive (such as Kohl's Cash).
A. Ullman understood that paying a 'big' name for a celebrity endorsement of the product was a bad idea if the product itself was too cheap to offer value to the consumer. Martha Stewart Living (MSO) is one example of this problem, and J.C. Penney has cut back on its utilization of space for this brand. Instead, Ullman is bringing back the old classic brands that people always liked, such as St. John's Bay and Liz Claiborne, and he has also given them good store space to help them sell (by replacing brands such as Martha Stewart and Joe Fresh).
B. Space is the name of the game in retail. The sales per square foot was falling for JCP according to this rather negative Seeking Alpha article. The per foot sales fell to $116 during 2012 from $154 in 2011 and we have yet to see how bad 2013 will be (or perhaps Ullman reversed the ship before year end). The reason in retail that sales per square foot is so important is because most of your cost is with respect to the real estate that a store sits on. Any space that is not used is a cost that must be made up by a higher Gross Profit margin for each item selling.
A number that is too high, can be an indication that the company is pursuing a low cost provider strategy and therefore they need high turnover. Or, a very low number could be a sign that the company is pursuing a differentiation strategy, which means that they need to sell items with very high profit margins. However, I chose Macy's and Kohl's specifically because they compete directly with J.C. Penney and have a similar strategy. For the Market that J.C. Penney is in, a 4.5 Inventory Turnover Rate is required. Without this rate, we can assume that JCP will have problems (as they clearly are having these issues). Ullman certainly understands the importance of the turnover rate. You can see this visually, as the rate was close to the 4.5 range when he exited the CEO position, making way for Ron Johnson. We can only assume, that he will be fixing this problem quickly.
However one does not need to simply look at the numbers to know that a decline per square foot in sales should have been the expected outcome for JCP. One could simply walk through multiple stores at different locations to see that the merchandise was not laid out properly (and if you are confused by what I mean, then head down to Macy's). Once again, Ullman seems to understand this problem and is working to fix it.
C. Ron Johnson disliked the idea of discounts very much. Having come over from Apple (AAPL), where his retail division sold one type of product for which there was virtually no competition, he did not understand the concept of discounts for clothing. But, people like discounts, and companies that figure out how to keep people coming back to buy clothes really have an advantage (Kohl's Cash is a good example of this).
Once again, success in retail is not rocket science, but it does require some level of understanding of the spatial limitations and their corresponding costs. Good quality clothing and housewares regardless of the celebrity endorsement are also important. The perception of discounting is another important factor as it drives traffic into the stores. I think that Ullman, who has a solid track record in the retail of clothing and house wares (not selling computers) can understand this and consequently improve JCP.
I really think that J.C. Penney is a good 'buy' provided that one has a long enough time horizon for this stock to rebound. It will not be an easy ride, JCP is bound to bounce up and down for the near future until some solid results start hitting the score board. But, if one is willing to ride out the storm, JCP provides solid value with respect to an adjusted P/E Ratio, the P/B Ratio, and with respect to analysis of management. I think for the long-term hold type of investor who is interested in some solid discounted stocks that provide enormous potential for value, JCP is the way to go.