J.C. Penney - Not Buying The Transformation

| About: J.C. Penney (JCP)

One of the cardinal rules of investing you hear often is "don't invest in what you don't understand." That leads me to J.C. Penney (JCP). I do not understand who shopped at these stores before CEO Ron Johnson started his transformation and I do not understand who is expected to shop at the stores after the transformation is complete.

The story is quite familiar by now. J.C. Penney CEO Ron Johnson, the former retail chief of Apple (AAPL), eliminated J.C. Penney's familiar coupons, discounts and markdowns and instituted a "Fair and Square" pricing strategy through which J.C. Penney now claims to offer everyday low prices in place of discounts and sales.

The strategy is part of what Mr. Johnson calls a transformation of J.C. Penney into a specialty department store.

The results thus far have been an unadulterated catastrophe. J.C. Penney's first quarter results represented the company's worst performance in 40 years. Then came the second quarter results and they were no better. Comparable store sales fell 21.7%. Total sales fell 22.6%. Internet sales fell 32.6%. The company lost $147 million. Revenue was down nearly 23%. Customers dropped by 12%. Moody's downgraded the company. Analysts had expected a Q2 loss of $0.26, with the company missing by $0.11 coming in at $0.37. The 12% decline in customers adds to the 10% decline J.C. Penney experienced in the first quarter.

In the face of these numbers here is what Mr. Johnson had to say:

We have now completed the first six months of our transformation and while business continues to be softer than anticipated, we are confident the transformation of J.C. Penney is on track.

Softer than anticipated seems to be an understatement. Confident in the transformation? Based on what? How did the stock price react? It went up, of course.

Beyond the poor financial results, what is more alarming is that J.C. Penney shoppers do not appear happy or excited about the transformation. As reported in Business Insider, here is part of a letter from a loyal J.C. Penney shopper to CEO Johnson:

Think of the way most women have a best friend. For many of us, our favorite department stores and brands are like best friends. We rely on them to offer what we need and provide support and interest in our lives. Large-scale drastic changes to stores and brands are akin to having a best friend become a completely different person and leave the friendship. This effect is compounded when a favorite retailer suddenly sends signals that you as a customer are no longer valued or wanted. Not only does it create discomfort, but it shatters trust and causes emotional pain.

... Your customers are not being treated "Fair and Square". We are being treated as mindless idiots who can't possibly understand your grand strategy. We see your new Personality and feel betrayed by it. We understand your Pricing, we just don't like it. Your Promotion offends us and makes us feel like we no longer matter as customers. Your Products are becoming cheaply-made trends that don't provide what we want and need. Your Presentation and Place create a clean-looking cold and shallow experience that drives shoppers away. And finally, your People are being replaced by cold uncaring technology or transient workers who could care less about the true customer experience. You've transformed the retail experience by destroying it.

As a Platinum-level J.C. Penney cardholder and customer since 1995, I am shocked and upset by what you have done to my former favorite store.

So it appears that I am not the only one that does not understand what is going on at J.C. Penney.

Because the consequences of J.C. Penney's transformation appear to involve driving away at least 10% of current J.C. Penney shoppers (at least temporarily), it would seem as though the Mr. Johnson's transformation hinges on J.C. Penney attracting customers who currently do not shop at J.C. Penney. Well Mr. Johnson, I wish you the best of luck, but count me as skeptical.

From a personal perspective, I have not stepped foot into a J.C. Penney in years. Even during its heyday, I think the only reason I ever went to a J.C. Penney was to return an unwanted gift I received from someone else.

Admittedly, I am not a typical shopper, so I asked my wife. She too has not gone to J.C. Penney in years. She said that for her when it comes to considering J.C. Penney, there is simply always a better alternative.

Lets look at those alternatives and when you see the names and picture what you buy at these stores, you will begin to appreciate the uphill battle that J.C. Penney faces.

On the bargain side you have Kohls (KSS), Target (TGT), or even Wal-Mart (WMT). On the higher end you have Bloomindales (M), Macy's (also M, and Nordstrom (JWN). In their own proxy statement J.C. Penney used all of the above companies (save for Wal-Mart) as comparison companies as benchmarks for determining compensation, as well as TJX Companies ("TJX") (T.J. Maxx, Marshalls, Home Goods), Gap, Inc. ("GPS") (Gap, Banana Republic, Old Navy), Limited Brands ("LTD") (Victoria's Secret, Bath & Body Works, Pink, Henri Bendel), and Sears ("SHLD").

Why would I go to J.C. Penney? Why would anyone go to J.C. Penney?

All of this said, that does not mean that an investment in J.C. Penney stock is a bad short term investment. Looking at the 5 year weekly chart you can draw an intriguing trend line.

You also have heavyweight activist investor Bill Ackman owning 39 million shares as of June 30 through his fund Pershing Square. That is same number of shares it held as of March 30, so Mr. Ackman is certainly still a believer at this point and plenty of people have made plenty of money following Mr. Ackman's lead.

So while the chart and Mr. Ackman seem to indicate that now might be a good time to buy despite the dismal results thus far this year and Mr. Johnson seems to think the transformation is on track, the question is, on track for what? Those who remain confident in the transformation seem to be looking at it through Apple colored glasses.

It appears that retail customers are abandoning J.C. Penney and unless you understand the J.C. Penney transformation better than I do, I would suggest if you are a retail investor that you stay on the sidelines as well. Until I can think of a reason I need to go shopping at a J.C. Penney, I do not feel confident buying or owning the stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: Nothing contained herein shall constitute financial, investment, legal and/or other professional advice. Investors buy and sell securities at their own risk.