J.C. Penney Company Inc. (JCP) is much maligned. It's down nearly half from its top, and still trending down. Every day, analysts and pundits go on CNBC and lambast the company. People no longer go to J.C. Penney, as they once used to. Given the bad conditions, what should investors do?
- J.C. Penney originally had a coupon strategy that worked. It may not have yielded $300 revenue/sq ft, but it made J.C. Penney $250 to 500 million a year. Then about a year ago, former Apple retail chief Ron Johnson became CEO and instituted an everyday low pricing strategy in lieu of coupons. Instead of testing it on one or two stores, Johnson adopted the strategy on all stores, and it didn't work out.
- Because of the pricing shift, same stores sales (Q) were down 19% yoy and online store sales were down 28% yoy. J.C. Penney burned through $600 million of cash.
- Some sell-siders say that most people who left JCP won't come back, because they've gone to Target (TGT) or Wal-Mart (WMT), instead of stores such as Macy's (M).
- The 'do the math' marketing was flawed. It's like Jimmy Carter's crisis of confidence speech. Never tell the customer that they're stupid - the customer is ALWAYS right.
- Ron Johnson has learned his lesson. He will no longer take transformative actions and try to rip the band aid off the wound. Instead of sticking to the everyday low price strategy, he has shown that he is open to bringing back the sales pricing model. It's tough for anyone to admit to making a mistake and changing, but Ron Johnson has shown the capacity to do it. There is no reason to think that he won't do market research the second time around.
- Bill Ackman owns 16% of JCP and still believes in it. Ackman is a long-term activist investor and to a fellow shareholder, that's the best type of investor. Ackman stuck with his Target position for four years. It didn't work out for him, but it shows that he's in it for the long term and not someone willing to sacrifice the company to make a quick buck. Ackman is very connected with management and has shown previously that he can get the CEO to do the right things to unlock long-term shareholder value.
- J.C. Penney planned to cut $900 million in costs per year. They're ahead of schedule. Assuming sales normalize, $900 million in savings will almost double JCP's earnings.
- It might not be a good thing for shareholders, but suspending the dividend will give J.C. Penney financial flexibility to transform itself.
- A recent Pershing Square report showed that private equity firms wanted to buy J.C. Penney back when Ackman announced his stake. Given J.C. Penney's stock price is now 30 percent cheaper, there is reason to think that private equity firms might still be open to buying it now.
As Ackman said, management expertise is the most important thing in deciding whether J.C. Penney thrives or dies. People make mistakes and Ron Johnson clearly made one. He has a second chance to correct his mistake. Going forward, there are basically two scenarios:
- J.C. Penney's sales revert back to historical norms or go higher. In that event, given the $900 million/year in cost savings, J.C. Penney's shares will start to tick up meaningfully. If a couple bumps on the road appear, private equity firms will offer to buy it, offering a free put to investors.
- Customers who left J.C. Penney don't come back and the company doesn't have enough money to go through the process of transforming itself. Deteriorating macro conditions or another Ron Johnson mistake causes J.C. Penney to undergo a vicious down cycle that ends with shareholders being diluted and/or private equity firm buying it a low price. (George Soros' Reflexivity theory.)
There is basically a fork in the road leading to two different outcomes, and as of right now, things are very uncertain. For long-term investors, it is probably a safer strategy to see if J.C. Penney's sales normalize/stabilize next quarter, so that investors know which road JC Penney will undergo.
Disclosure: I am long JCP.