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Teflon Ron is at it again. On Wednesday afternoon, J.C. Penney (JCP) CEO Ron Johnson led Wall Street analysts on a tour of his company's model store in Texas. The purpose of this tour was to show analysts what a J.C. Penney store will look like after the brand's "transformation" is complete. Each full-size J.C. Penney store will be broken up into 100 brand-oriented shops, with other services being offered in the aisles ("the Street") and a central square. As has become common since Ron Johnson took the helm at J.C. Penney last November, there was a lot of hype involved in the presentation. J.C. Penney stock spiked by more than 10% intraday after Johnson announced that the 12 existing shops have been outperforming the rest of the store by more than 20%. This is a big number and implies that better merchandise presentation (via the "shops" concept) may improve J.C. Penney's results over time.

Unfortunately for J.C. Penney bulls, there was another side to the story. After extolling the success of the 12 shops that have been rolled out to date, Johnson admitted that these improvements have not been nearly enough to turn things around at J.C. Penney. "The last two weeks have been much tougher than we planned," Johnson stated. In light of this statement, the initial announcement that the shops have been outperforming the rest of the store by 20% seems downright misleading. Multiple news outlets reported that the shops had 20% or better comp figures, which would be a very good thing if true. However, it seems far more likely that comps for the shops are flat to down single digits and the rest of the store is down 20-30% (which still tallies to 20%+ outperformance for the shops).

At the end of the day, analysts should have walked away with yet another reason to distrust J.C. Penney's management. Earlier this month, I wrote that J.C. Penney's management finally seemed to be regaining their grip on reality. At that point, CFO Ken Hannah had recently given seemingly conservative guidance, and had indicated that the pace of the transformation would be dictated by future cash flows. However, today's announcement that the last two weeks have been weaker than expected indicates that Hannah's recent guidance (for a continuation of -20% comps) may be off the table. If so, this would be the third downward guidance revision in the past four months for J.C. Penney. It thus appears that my earlier thesis (that J.C. Penney's management was in denial) was closer to the mark.

It may be hard to imagine any downside from -20% comp store sales, but as Brian Sozzi of NBG Productions suggested on Wednesday, J.C. Penney customers are still hooked on coupons. Of course, J.C. Penney doesn't offer coupons anymore, but other stores do. Macy's (M) and Kohl's (KSS) are the two stores that quickly come to mind here. Macy's sales were up nearly 6% last month, while Kohl's sales were up more than 5%. It is very likely that these two competitors (and possibly others) took market share from J.C. Penney in spite of the latter's free haircut promotion. While J.C. Penney will bring free children's haircuts back (on Sundays only) in November, in the meantime the company has no tools available to buoy sales.

In spite of all these problems, some analysts seem to have their heads buried in the sand. Brian Nagel of Oppenheimer appeared on CNBC this afternoon to say that the market has seen "incrementally, increasingly positive data points from J.C. Penney." It's not clear what Nagel means: certainly the company's two presentations this month have had a raft of bad news to overwhelm any "positive data points". In his commentary, Nagel focused on the positive response customers have had to the new "shops" format, and seemed to downplay the ongoing poor sales trends. Retail consultant Robin Lewis one-upped him, telling Bloomberg that J.C. Penney's sales could eventually hit $350/square foot, even as the company's sales are slumping below $130/square foot today.

The big problem with the J.C. Penney story, as I discussed in my last post, is that the speed of the "shops" rollout will be determined by the company's cash flows. J.C. Penney's dreadful sales and earnings this year have almost entirely eaten through the company's cash cushion, despite the monetization of some real estate assets this summer. Management's recent commentary suggests that, as popular as the new shops may be, positive results there have been overwhelmed by weak sales trends in the rest of the store. Continued weak operating results will result in lower-than-planned cash flow (directly, because of lower earnings, and indirectly, because of having excess inventory), and thus slow down the rollout of additional shops. J.C. Penney may need to have 40-50 shops installed to reach a "tipping point" where the concept begins to drive noticeable improvements in sales. Management was hoping to reach that point next year, but it seems increasingly likely that the company will not get there until 2014.

This year's weak results at J.C. Penney are not a blip. The company is going through a very rough rebuilding process. Even if the transformation is ultimately successful, it could take five years or more for J.C. Penney to return to historical levels of profitability. The cost of the transformation could approach $4 billion over four years, which will prevent the company from returning any cash to shareholders over that time period. Owning J.C. Penney today opens you up to a mountain of risk if sales remain near current levels for a prolonged period of time. The potential upside is distant and highly uncertain. In the meantime, we are likely to hear a lot more bad news from J.C. Penney, which provides a good shorting opportunity for bears now, and better buying opportunities for bulls later on.

Source: More Broken Promises At J.C. Penney