J. C. Penney's (JCP) stock price recently plummeted by 11% after its CEO, Johnson, said that tough financial conditions would continue throughout the full year. It is tough to regain customers in an economic environment where competitors are doing their best to attract traffic. JCP's management is trying its best to turn around the retailer's situation, but we are still bearish about the company's prospects, given the challenges it is set to face in future.
Below are the reasons why we are not bullish on JCP, despite the 30% YTD share price decline:
- Last quarter saw another earnings miss, with a 22% decline in revenues. Margins have also declined.
- Same store sales and traffic were also down for 2Q2012.
- Cost cutting is not a long-term solution to the company's troubles, as analysts expect revenues to decline by 18% and 12% YoY in the next two quarters. These revenues include the all-important back to school shopping season for retailers.
- Back to school promotions like free haircuts for kids failed to impress customers, partially because the company might have been trying to target additional younger customers, as compared to older and more loyal customers.
- The "new shops within stores" transformation had initially showed some positive results, but an assessment just now will be premature because the strategy is still in the process of completion. Only 12 such 'shops within stores' had been opened as of September 1. Despite the reported 20% higher sales at these new 'shops within stores' (mainly denim), CEO Ron Johnson conceded that the "the last two weeks have been much tougher than we planned". The company wants to complete 100 specialty boutiques by 2015, which will not be realized any time soon; there is still uncertainty as to whether the appearance of these stores can induce enough customers to spend.
- The replacement of checkouts with mobile and self checkouts will also be wound up by 2014.
- The transformation could cost JCP $4-$5 billion. The cash flows needed to support this expenditure will continue to face pressure because of the company's weak financial performance in the short-run. The operating cash flow (trailing twelve months) is a low $39 million, and the total debt-to-equity ratio is 85%; the interest coverage ratio is 3.5 times.
- Since our first article on JCP, the short ratio has increased from 4.4 to 5.8 days.
- Competitors like Nordstrom (JWN), Macy's (M) and Gap (GPS) have been quick to benefit from JCP letting down its customers. Target (TGT) and Wal-Mart (WMT) are strong home goods competitors.
The present uncertainty regarding the success of the turnaround strategy does not warrant an EV/EBITDA multiple that is more than those of the company's peers. JCP has an EV/EBITDA multiple of 22.5x, as compared to M's 6x, TGT's 8x and GPS's 8x. The 10% increase in the stock price in the last three months is not supported by the deteriorating fundamentals. This makes investing in JCP risky.
The company is in for a lot of short-term challenges before its turnaround strategies start bearing fruit by roughly 2014, if they bear fruit at all that is. These challenges include low traffic, inventory buildups, financing the turnaround measures, and customers taking time to accept everyday low pricing in place of the coupons that were previously the main attraction. In the meanwhile, there is no shortage of choices for estranged JCP customers when it comes to retailers carrying apparel and home furnishings, among other items.