It has not been a good week for J.C. Penney (JCP) shareholders. On Tuesday afternoon, J.C. Penney reported that it swung from EPS of 28 cents last year to a Q1 loss of 75 cents per share. Perhaps the worst news was that same store sales were down a whopping 18.9%. Both of these figures fell well short of analysts' already much reduced forecasts. Gross margins also contracted by 310 basis points to 37.5%, despite the fact that J.C. Penney's new strategy is designed to keep gross margins up by selling merchandise at full price.
In other bad news, while top competitor Macy's (M) reported a 33.7% rise in internet sales over 2011, J.C. Penney reported a 27.9% year over year drop in internet sales. Considering that e-commerce is the wave of the future, this is not good. To compete better with Amazon (AMZN), most department stores have moved to offering free shipping for online purchases, even though this results in a hit to gross margin. J.C. Penney's results suggest that as more and more sales move away from the storefront and onto the internet, the company be unable to capture a piece of these sales.
The result of all this is that shares have dropped from an intraday high near $35 on Monday to a Thursday close at $25.94. Wednesday alone was the worst day in J.C. Penney's trading history, with a 19.8% loss. To make matters worse, S&P cut J.C. Penney's credit rating further into junk territory (at BB-) on Thursday afternoon and placed the company on negative credit watch. Given how far J.C. Penney's Q1 performance fell below expectations, I expect Fitch and Moody's to cut J.C. Penney's credit ratings as well. This will make it more difficult for J.C. Penney to roll over existing debt at favorable interest rates and to issue new debt (if necessary) to support investments in the business.
As I've been writing since my very first post on Seeking Alpha six months ago, J.C. Penney has been a disaster waiting to happen. I do not claim to have the retail pedigree of Ron Johnson, but it has been obvious even to a non-specialist that J.C. Penney faces massive structural challenges (under the old strategy as well as the new one). I have therefore held a short position in J.C.P shares for quite a while. However, I closed roughly half of my remaining position at $28.70 in after-hours trade on Tuesday, and then closed out the remainder on Thursday afternoon at $25.94. I think this past week's news vindicates my placement of a $25 price target on J.C.P shares, which some commenters found ridiculous at the time.
While I have closed my short position, I do not recommend that investors rush into J.C. Penney shares at this time (either long or short). I think there is further potential downside as far as $20, but on the flip side, a few key players who are already invested in the stock (such as Bill Ackman, Steven Roth, and Whitney Tilson) could snap up enough stock that the price could rebound. Alternatively, significant macroeconomic improvement could provide a bounce. Based on my personal appetite for risk, I was happy to pocket profits at current levels and walk away for the time being.
I think there is still an intact fundamental short thesis for J.C. Penney. Macy's is already eating its lunch, and I expect Kohl's (KSS) to start taking some share given its 2012 emphasis on better value (i.e. more coupons and promotions). However, the big reason why I see more downside for J.C. Penney is that I think management and investors still have not fully come to grips with how difficult the adjustment process will be. This is fairly remarkable, given how awful the Q1 numbers were. Bill Ackman (the company's largest shareholder and a board member) stated on Wednesday that management would begin to turn things around in August. Furthermore, while analysts are still in the process of revising their sales and earnings estimates, the current estimates (as reported by Yahoo Finance) actually imply year over year sales gains for Q4. The share price thus might not reach a truly "fair" value until J.C. Penney reports its full-year results next February.
I will lay out my prognosis in more detail in a follow up piece next week. For now, I wanted to provide an update and recommend that investors avoid the stock for the time being. Suffice it to say that I do not think things will get better for J.C. Penney anytime soon. However, there are plenty of people out there who have convinced themselves that relief is right around the corner, and they could potentially drive the stock back up. If the stock makes it back above $30, I would view that as a fresh short opportunity.