Since August 2010 Bill Ackman has built a sizable position in JC Penney (JCP) stock, accumulating a little under a 20% stake in the national retailer. Since then, he has managed to gain board seats for himself, Steve Roth, CEO of Vornado Realty Trust (VNO), and install Ron Johnson -- the mastermind behind Apple's (AAPL) wildly successful Apple Stores, and who previously turned around and improved Mervyn's and Target (TGT) -- as CEO. After making these changes Mr. Ackman presented at the Ira Sohn Conference where he formally outlined his investment thesis, and Mr. Johnson spoke at length at investor day about his vision for the company at analyst day this year. Taken together, we can gain a deep insight both as to the attractiveness of the investment for Mr. Ackman, and Mr. Johnson's retail strategy. In this article I will highlight and summarize the main points Mr. Ackman and Mr. Johnson made in their presentation, after which I will address the initial results of this strategy, and overall recommendation.
Mr. Ackman's presentation can get broken down into two main pieces:
1. JCP's current assets, which make it an attractive investment.
2. New managements strategies to enhance those assets.
In his presentation, Mr. Ackman lists the company's real estate assets, its strong brand, and sourcing ability as its main competitive advantages. Mr. Ackman then transitions into two main points -- the company's ability to harness current advantages, and their ability to cut costs. Mr. Ackman references many points from Mr. Johnson's presentation at analyst day, where Mr. Johnson gave six, "P's" that get to the heart of the retail business. Mr. Johnson quoted a well known retailer, that if you can get one of these right, you can do well, get two right you will do great, and the more of them the better you will perform. The six, "P's" are:
Mr. Johnson hopes to change JCP's personality by dramatically freshening up the brand, and transforming JCP into an, "honest, and simple" retailer. His main issue, and this leads into the price problems, is that JCP ran essentially on a purely promotional basis, so much so that less than .5% of their products got purchased at the full retail price. Mr. Johnson thinks consumers do not like the, "run around" of coupon clipping, and would prefer an honest -- fair and square -- system they can easily understand. Mr. Johnson plans to heavily promote this strategy through a new, cheaper, but more effective advertising campaign. Once the personality, price, and promotion stars get aligned, Mr. Johnson plans to bring in new products that JCP couldn't get before because of their promotional strategy, and which Mr. Johnson believes will dramatically increase sales. Finally, Mr. Johnson plans to dramatically remake the layout and presentation of the department store, by dividing the store into 100, "shops", and recreate the place by adding a town square section of the store that customers can use as a service before, during, and after their shopping.
This, in a nutshell, gives the broad strokes of Mr. Johnson's plan, which he already started implementing, and plans to finish full implementation by 2015. Mr. Ackman thinks these strategies will allow JCP to reach back to its $177/sq ft in sales that they saw in 2007 before the macro economic downturn, which would increase EPS by ~$2.40. In his later slides, Mr. Ackman then gets ambitious (or as he puts it, "Thinks Big") and predicts that because of Mr. Johnson's, "100 shops" strategy JCP could turn itself into a specialty retailer, whom tend to have much higher sales per square foot than their mass market competitors. Mr. Ackman muses that if JCP could double its sales per square foot -- putting them on par with other specialty retailers -- they could increase their EPS from the current $1.49 to $15.
However, this only represents one half of the plan. In addition to the above, sales strategy, Mr. Johnson plans to aggressively cut costs, which will further add to EPS. Mr. Ackman (and Mr. Johnson on day 2 of investor day) cited the following cost cuts.
1. Home Office ($200mm) -- management plans to cut down on their unproductive workforce, poor HR structure, and expensive IT costs.
2. Stores ($400mm) -- management plans to decrease the workforce, both by firing excess employees, and by streamlining the sales, and stocking process
3. Advertising ($300mm) -- by moving away from their promotional strategy, management plans to save $300mm from advertising all of their former promotions.
In total, these savings total $900mm or ~120% o EBIT from 2011, which will add $2.50 to EPS by year-end. Putting both of these strategies together -- the sales increases and the cost savings -- JCP could see EPS in the range of $6 on the conservative side, to $22 on the ambitious side.
Taking A Step Back
While the above initiatives sound great, it could distract investors from the main point: how will JCP increase revenue? They have three options
1. Raise prices
2. Increase traffic
3. Increase amount current customers spend per store visit.
I have not gotten a clear picture on whether or not management expects to raise prices on their goods, but it seems clear they want to increase traffic and the amount people spend per visit. They have taken a major step forward in achieving those goals as outlined above. However, whether they succeed in their mission remains tough to call. Their plan sounds good, and it looks good, but they had a major drop in Q1 2012 revenue -- down 20% from the same quarter last year. Management chalked this up to customer dissatisfaction with JCP's new pricing strategy -- one that eliminated all coupons, in favor of the "favor and square" model. Additionally, they claimed they did not communicate their strategy clearly enough with customers, which also contributed to the major revenue drop. Management has made some bold moves that could ultimately prove wildly successful, but the direction could prove misguided, and the plan could fail.
However, despite this, I still think JCP remains a strong buy because of the hedge investors will get from the cost savings. In his presentation, Mr. Ackman said that each $100mm management decreases in expenses, will add ~30 cents of EPS, and with management targeting $900mm in cost savings that should add $2.70 of EPS by year end. Management sounded enthusiastic about the success of this plan, and reaffirmed, and even vaguely upped their expectations for the cost savings. This element of the turnaround plan provides an effective hedge for investors wishing to get in now before the stock becomes too expensive, but want need some downside protection. Because management has more control over these issues, as opposed to consumer opinion, investors can take refuge in this more assured addition to EPS.
Mr. Johnson has definitely breathed a new sense of life into JC Penney. He seems to want to actively transform it, and truly freshen up and liven the brand. Both from an internal operational perspective, but also, more importantly, from a consumer facing perspective. His leadership and direction can definitely make for large gains going forward. Consider the possibilities, last year, Kohl's (KSS), a company that competes directly with JCP made $229/square foot, nearly 75% more than JCP's $132/square foot. Put differently, according to Mr. Johnson, JCP had a 3% market share in its main categories last year, that puts the market JCP competes in at about $550b -- giving JCP a lot of room to grow.
Investors can still get in at reasonable prices. As of the writing of this article, (June 5) JCP was trading at 24.50. Mr. Ackman has made many trades both in the stock, and the options for the last two years, with an average price of around $31.50 in the common stock. Therefore, investors who believe in the company's direction, and my investment thesis about the downside protection, can still get in at a very attractive price, wait out the current bumpiness, and possibly see very attractive returns.