How J.C. Penney Can Break Out Of This Hole

| About: J.C. Penney (JCP)

Since I wrote my article about why I thought J.C. Penney (NYSE:JCP) could double and was at least good for a trade, not much has actually happened at the retailer, yet the stock and bond prices continue to languish on high volume. In short, there has been no bottoming despite $800mm in new liquidity. This lack of movement is particularly curious in the case of the bonds where the equity raise is unadulterated good news - a lot of new money beneath you. I still believe that no news to good news has occurred since the offering and that the stock and bonds are down for technical and sentiment reasons. A summary of recent events:

  • $800mm of liquidity raised in a ham-handed way that burned investors, but bought time for at least a year if not longer to turn the business around.
  • The Company reiterates its year-end liquidity position - indicating that things are not getting worse at least in the short term.
  • The former CEO of Saks, Stephen Sadove, joins the board as Chairman. A real executive who made good money for his shareholders in Saks (selling it to Hudson Bay) and would be a logical CEO to replace Ullman, who is interim. It would be unusual for an executive of his standing to join the Company only to take it into Chapter 11 soon after.

Many investors bought into the offering with an expectation of a post-secondary pop, which has failed to happen to say the least. And we have seen public fillings of one high profile investor exiting. Today, Kyle Bass is out saying how he is disappointed with the dilution from the offering. What he also says is that all JCP needs to do is stabilize to see double digit comp store gains. I agree with everything he is quoted as saying. The offering was a mess and handled badly and has damaged management credibility, which explains part of the reason why the stock can't rise. With the long dated bond prices in the 60s and 70s, I believe that some of the bigger credit funds are probably buying bonds and shorting stock against them. After all, you are earning an hefty current yield and have the chance for 30 or more points of appreciation at maturity with a stock short to hedge the default risk. This credit arbitrage exacerbates selling from investors who were burned by the secondary and the already large short cohort.

To top it all off, the market has been heavy and retail in particular has been weak both in terms of results and stock prices. Assuming that Funds have these long credit/short stock trades on, they can also be unwound in a hurry. A stabilization and return to positive comps should produce a 15-20% move in most of the longer dated bonds which is fantastic for a bond. The stock should at least return to the offering price in the face of that kind of news for a low 20s return. The stock is up a bit today on the Sadove news in a very bad tape. As discussed, the stock is massively shorted, it is conceivable that the credit funds might be over hedged and that the stock could shoot way past the offering price. After all, the investors that bought the 80mm+ shares had to be expecting a positive rate of return. The bonds can only go to par and the stock can theoretically go to infinity. So just as the sentiment, shorting and selling from the offering is putting a lid on the stock. A mere stabilization of trends and slightly positive comp sales number could and should get the stock to break out as funds unwind part or all of the inter capitalization arbitrage.

Disclosure: I am long JCP. 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.

Additional disclosure: Though positions can and do change without warning or notice.

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