J.C. Penney - Dramatic Holiday Quarter Shows That Transformation Is Still Causing Turmoil

| About: J.C. Penney (JCP)
This article is now exclusive for PRO subscribers.

Shares of J.C. Penney (JCP) lost 17% in Thursday's trading session, after recovering more than 5% from the lows of the day. The plagued retailer announced a very weak set of fourth-quarter results, triggering a renewed sell-off in its shares.

Fourth Quarter Results

J.C. Penney reported fourth-quarter revenues of $3.88 billion, down 28.4% on the year before. Sales fell sharply even as the fourth quarter included $163 million in sales from the 53rd week in 2012.

Comparable store sales fell an incredible 31.7% for the period. Even the internet activities, which typically show higher growth rates for most retailers, reported a 34.4% drop in sales to just $315 million. Sales fell way short of analysts expectations of revenues of $4.08 billion.

Gross margins collapsed to just 23.8% of sales, down 640 basis points compared to the year before. Lower sales and higher clearance sales, to reduce the level of inventory, impacted margins. The company did manage to cut its total inventory position as a result by 20% over the past year.

J.C. Penney reported a net loss of $552 million, or $2.51 per share. Excluding restructuring and management transition charges, as well as non-cash pension plan expenses, adjusted net losses came in at $427 million, or $1.95 per share. Losses were much worse compared to the most pessimistic scenarios of analysts, as on average the investment community was anticipating the company to report losses of $0.18 per share.

CEO Ron Johnson commented on the disastrous results, "Sales and customer traffic were below our expectations in 2012, but as we execute our ambitious transformation plan, we are pleased with the great strides we made to improve jcpenney's cost structure,technology platforms and the overall customer experience. We have accomplished so much in the last twelve months. We believe the bold actions taken in 2012 will materially improve the Company's long-term growth and profitability."


The company is not just restructuring, but also transforming its business at the same time. J.C. Penney anticipates to open 20 shops for home products with many of its partners. The company will furthermore open nearly 700 Joe Fresh apparel stores during spring and another 60 Sephora stores inside its current J.C. Penney stores.

CEO Johnson commented on the near term plans for its transformation plans, "Looking ahead, we are energized by our shop roll out plans for 2013 and the exciting work our teams are undertaking to transform the store."


J.C. Penney ended its fourth quarter of 2012 with $930 million in cash and equivalents. The company operates with $3.0 billion in short- and long-term debt, for a net debt position of roughly $2.1 billion.

The company reported full-year revenues of $13.0 billion for 2012, down 24.8% compared to 2011. Net losses widened from $152 million in 2011 to $985 million over the past year.

Factoring in Thursday's losses, the market values J.C. Penney at $3.8 billion. This values the firm at merely 0.3 times annual revenues.

Given the financial difficulties and the early stage of the transformation phase, the firm does not pay a dividend at the moment.

Investment Thesis

Shares of the troubled retailer have lost more than half of their value over the past year. Shares fell from $40 at the start of February in 2012 to $20 in July of that year. Shares recovered to $30 in October, but fell back to lows of $16 on Thursday.

Shares of J.C. Penney peaked at $80 at the start of 2007, when American consumers were using their ever increasing home equity as a credit card to finance retail spending. Shares fell to current levels in 2008 and 2009 and have traded in a wide $20-$40 trading range ever since.

Between 2008 and 2012 the firm has published stagnating revenues, before they fell of a cliff in the last year. The company reported modest profits in between 2008 and 2010, before reporting a massive loss in 2012.

Bad News Show

The bad news kept coming even after the figures. In reaction to the results, credit rating agency Fitch downgraded J.C. Penney from B to B minus with a negative outlook. The company remains strained with regard to its liquidity but the overall leverage position seems manageable.

The company recently upped the size on its $1.85 billion in revolving credit line of which $1.2 billion is still available, until at least April of 2016. Furthermore, the debt repayment schedule is favorable with no debt repayments in the coming two years. Additionally, repayment maturities until 2018 are limited to merely $200-$300 million per annum.

Investment Thesis

As a result of the disastrous results, J.C. Penney ended the year with less than $1 billion in cash and equivalents. This is despite the fact that the company managed to cut inventory by 20% compared to the year before, coming in at $2.34 billion.

Johnson's plan to eliminate coupons, discounts and sales events for a "everyday low pricing" strategy has sent away many loyal customers of the retail giant. During the year the company has already made adjustments by allowing limited sales events for private items. The company has also continued its investment in re-fashioning existing stores and the creation of boutique stores to create a younger crowd.

The adjustments to the original strategy allows for limited sales and coupons to attract some of Penney's core crowd back. At the same time, the company remains on the long-term trajectory of everyday low pricing.

The latest dramatic results will continue to put pressure on CEO Johnson. The company's competitive position was slowly slipping away over the past five years, but this was occurring at a very modest pace. His transformation efforts, although well-intended, have caused a lot of turmoil, long-term customer damage and short-term financial stress.

Key for the short term will be to stabilize same-store sales, but the pace of same-store sales declines has actually accelerated in the final quarter. CEO Johnson, the former executive of Apple's (AAPL) retail business, acknowledges his mistake. His position is coming under pressure and the time window for him to perform is running out. This is despite the fact that he still receives support for J.C. Penney's top shareholder,William Ackman who runs Pershing Square Capital.

It has been August since I last took a look at the prospects for J.C. Penney. At the time, investors were still giving Johnson the benefit of the doubt despite the dramatic results. Support for Johnson is evaporating, and so is the share price amidst the disappointing results during the important holiday season. In hindsight, Johnson's actions were too drastic and implemented too quickly, threatening the weakening core of the business even more.

Investors should stay on the sidelines, as the business is not yet stabilizing. I guess it might be too early in the process, despite the fact that the turnaround already been started 12 months ago, to pick up some shares. For now, things might be getting worse before they get better. Fortunately the liquidity position for now seems good enough. If shares were to drop significantly more, opportunistic investors could buy it as a long-term call on a better future and successful transformation in the long haul.

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.