Short Idea: J.C. Penney Is The Netflix Of 2012

| About: J.C. Penney (JCP)

We all know the story of Netflix (NASDAQ:NFLX) in 2011. For the first half of the year, the stock price grew from less than $200 to over $300. Every time Netflix made a new announcement, it seemed that the stock would reach new highs. While some investors doubted the story that Netflix was selling, for the most part they sent the stock to higher and higher earnings multiples.

Then came reality. While analysts and investors initially put on a brave face in light of Netflix's price changes, things quickly unraveled. Many customers left, and the stock dropped like a rock, bottoming out below $70. While the stock has jumped more than 60% off of its lows, investors that bought Netflix shares near their peak have still lost more than half of their investment in less than a year.

Today, J.C. Penney (NYSE:JCP) looks to me a lot like Netflix did at this time last year. (To be honest, Netflix of 2012 is starting to look a bit like Netflix of 2011, as well!) Both companies have extremely confident management, predicting rapid earnings growth despite obvious structural problems. At its investor summit two weeks ago, J.C. Penney executives predicted that 2012 adjusted profit would meet or exceed 2010's level of $2.16 per share. This is a tall order considering that adjusted profit has plummeted this year, with analyst consensus being $1.25 (probably an aggressive number). GAAP EPS will be significantly worse due to various restructuring charges, leading to a loss for the year.

Over the long-term, CEO Ron Johnson plans to completely reinvent the company and seems very confident that sales will increase. But even he realizes that customers may need to be "re-trained" to buy things that are not marked down 60% from regular price. During this transition, sales could remain stagnant or decline even further. Thus, management seems to be primarily counting on cost cuts to achieve this profit target. COO Michael Kramer announced a target of $900 million in expense cuts to be achieved over the next two years. The cuts will come from streamlining management, reducing the number of employees in stores, and simplifying advertising.

As I noted last week, there are a lot of open questions regarding management's plan for J.C. Penney. Expense cuts are straightforward enough, but management's faith in "fair prices" is backed up by precious little evidence to date. What we do know is that J.C. Penney shoppers in recent years have embraced coupons, sales, and other "deals", and thus might be a bit put off by the new prices. The company has had a hard enough time in recent years getting shoppers to choose Penney's over Macy's (NYSE:M), Kohl's (NYSE:KSS), or discounters like Target (NYSE:TGT). Since J.C. Penney is selling the same merchandise today as it was last year, the pricing policy is going to have to do a lot of "work" for J.C. Penney to maintain market share.

Perhaps the worst thing for investors is that, at the same time as making these changes, J.C. Penney has taken a big step backwards in terms of openness and disclosure. In this way, too, the company seems to be mimicking the path of Netflix. The company has stopped reporting monthly same-store sales figures, and will also stop providing quarterly sales and earnings guidance (which was previously given in the quarterly earnings release). Ideally, this will allow management to focus on the long-range plan rather than meeting arbitrary targets each month. However, it's more than a bit odd that management claims to be confident about growing earnings nearly 100% for the full year but won't say what it expects for a single quarter.

Investors thus will have a hard time gauging the success of the turnaround program until Q1 earnings come out (still more than three months away). Until then, it may be helpful to look at the numbers for those of Penney's competitors that still report monthly same-store sales. If (in the absence of a significant improvement in overall consumer confidence) Macy's, Kohl's, and Dillard's (NYSE:DDS) see an uptick in same-store sales, that would suggest that J.C. Penney was losing significant market share. On the other hand, if the recent trends for those stores continue, then investors could potentially be more comfortable with the J.C. Penney transformation.

As of now, the momentum in JCP shares has cooled off and the shares remain significantly overvalued compared to competitors. Until the company presents tangible evidence of a turnaround (i.e. profit and sales growth), I am maintaining my sell/short recommendation.

Disclosure: I am short JCP.

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