Last week, Business Insider ran a pair of stories documenting employee unrest at J.C. Penney (JCP) amidst large-scale layoffs at the middle management level. In the first story, workers described a secretive process of layoffs and store transfers that left many associates confused and demoralized. The second ran under the unflattering title "JCPenney Associate: 'It Has Become an Awful Place to Work." This article relayed one particular employee's take on the situation. It describes chronic under-staffing, little attention being paid to selling merchandise, and allegations that the company is being defrauded as a result of its lenient return policy.
All this is a far cry from the enthusiasm and optimism surrounding the new pricing strategy when it was first revealed in late January. When the new pricing scheme was first launched, most stories talked about how employees were energized by the new strategy. In February, most analysts seemed to expect a very quick "retraining" of customers with respect to the new pricing scheme. Since then, some analysts have become more worried that J.C. Penney is losing significant market share to competitors throughout the department store and discount store space.
While these are anecdotes that may or may not accurately reflect the realities of February 1 and today, the recent bout of pessimism appropriately highlights the execution risks J.C. Penney faces. The company is undergoing a major transformation in the context of a very cut-throat retail environment. J.C. Penney's strategy is predicated on competing based on service and merchandise quality rather than price alone. It is crucial for employees to be upbeat and to have the best products for sale. At this point, the products for sale are more or less the same ones that failed to drive sales trends over the past few years; new partnerships will not come into effect until later this year and next year. Meanwhile, the Business Insider stories referenced above suggest that a fair number of employees may already be disenchanted with Ron Johnson.
Thus, J.C. Penney faces a moment of truth, so to speak, when the company reports earnings next week. Analyst estimates have plunged over the past three months, with the current average estimate being an 8 cent adjusted loss per share, on an 11% decline in revenue. There is a huge amount of uncertainty behind these figures, since the company discontinued quarterly guidance for sales and earnings, and also stopped reporting monthly sales results. Even if the company meets analysts' estimates, it still faces substantial downside risk for the rest of the year. Current estimates imply a sales decline of nearly 10% for the first half of the year, but a decline of only 1% for the second half. J.C. Penney does face easier comparable figures in the second half, but an 800-900 basis point improvement in sales trends seems like wishful thinking.
On top of these company-specific issues, J.C. Penney also faces a retail landscape that may be weakening. Many of J.C. Penney's competitors reported weaker-than-expected April sales trends. Target (TGT) and Macy's (M) both posted same store sales increases of only 1% year over year. Meanwhile, Kohl's (KSS), which price-wise is probably J.C. Penney's closest competitor, posted a 3.5% decline in same store sales. This underperformance was in part due to the calendar shift of Easter, so that some holiday sales fell in March. However, there have also been renewed signs of macroeconomic weakness in recent weeks. Combined with less favorable weather patterns in April, consumers appear to have cut back on discretionary purchases. Among the department stores, only perennial loser Sears (SHLD) managed to post better than expected numbers.
J.C. Penney is a turnaround story, but it is still a stock investors should avoid until Ron Johnson's new strategy yields tangible results. I only see significant upside coming out of earnings if the company can post a profit (something it easily did last year) and total sales decline well under 10%. If results are even weaker than the market currently expects, I see downside into the mid $20s over the summer.