Peter Lynch's quip that the "problem with turnarounds is that they seldom turnaround" seems custom-fit to describe what is currently going on at J.C. Penney (NYSE:JCP). The company seems to be following the same long-term path that Eastman Kodak shareholders had to endure in the final two decades before bankruptcy: cut the meaningful dividend, then start to grow it a bit, then freeze it again, then eliminate it, and then stop making profits altogether.
After years of growing the dividend, J.C. Penney cut it from $2.18 in 1999 to $0.99 in 2000. Then, shareholders got a cut next year to only $0.50 per share. It started growing gradually until 2008, at which point the company froze the dividend at $0.80 per share. By 2013, the dividend was gone altogether. For those who follow the theory that dividend freezes or cuts can be a signal of nasty business conditions to come, J.C. Penney turned out to be the perfect case study example.
J.C. Penney's dividend has been a perfect predictor of future profit loss. From 2008 to 2011, the company held the dividend steady at $0.80 per share, and profits declined from $567 million to $152 million over that time frame. In 2012, the company cut its dividend to $0.40 per share, and then the company lost $767 million. In 2013, the dividend was gone entirely for the full year, and the company lost $1.2 billion.
The question then becomes: What is J.C. Penney doing to restore profitability and get shareholders on the path to receiving dividend income again?
And the answer is not anything to get excited about. J.C. Penney is taking on huge debt, issuing new shares, lowering capital investments for growth and is not modifying the business model in any way that can be used to make profits over the medium term.
First off, there's the debt. It has one of the ugliest balance sheets of any large-cap company I have ever studied. The only nice thing I have to say is that the company has had its pension obligations covered. It has $5.0 billion in liabilities, and has $5.0 billion in pension funds to handle it. Other than that, everything else is a wreck. It is sitting on $5.6 billion in debt. Over $3.3 billion of that is due by 2018. The interest alone on the debt is approaching $400 million per year. And, worst of all, the company is still losing money, so these figures might even get worse. It's not good when a company with a market capitalization of $2.7 billion is sitting on a debt load that is over twice its valuation. Heck, the long-term interest on the debt makes up almost 15% of J.C. Penney's market capitalization.
Then, there is the fact that J.C. Penney is issuing new shares as a way to get their hands on additional capital because it is quickly approaching its limit of how much debt it can take on. If you study the company's dilution over the medium term, we can see that shareholders are gradually getting fleeced. In 2007, J.C. Penney had 221 million shares outstanding. Now, the company has over 300 million shares outstanding. Not only is the company loading its balance sheet with debt while losing money, but it has also diluted shareholders to the tune of 37% over the past seven years. Even if the company returned to profitability, your share of the profits will be much less (as the company isn't done diluting shareholders, which can be seen by a share count that has increased every year since 2007).
And lastly, the company is only spending $300 million on capital expenditures (compared to about $1 billion last year). The store count is starting to decline to the tune of about 10 stores per year, which means that J.C. Penney can only achieve growth by improving performance at its existing stores. That seems unlikely, given that the company's gross margins aren't even at 30%, and that is problematic given that total revenues are down from $17.7 billion in 2001 to $11.8 billion now. Its general and administrative expenses are now at $4.2 billion, which is going to make it very hard for the company to turn a profit in the medium-term future.
I can't see any way that the company could bring back its dividend in the next five years. The share count is increasing, diluting shareholders. The company now has $5.6 billion in debt on its balance sheet, which is causing the company to pay almost $400 million in interest. Its expenses are so high (at over $4.0) that it can't even turn a profit because its margins on goods are 25% lower than where they were before the recession, and the revenue has been cut in half. With debt, dilution and profit loss, there's no way Penney can bring its historically strong dividend back within the next five years.
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.