Expect More Dilution From J.C. Penney

| About: J.C. Penney (JCP)
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In October I wrote an article in response to J. C. Penney's (NYSE:JCP) secondary offering in which I emphasized two points. The first was that it should have been no surprise to investors who were in tune with the developments in the company's balance sheet despite continued optimism from the company's CFO Ken Hannah. The second was that despite the fact that the company keeps referring to a "turnaround" that this hardly describes the situation at hand--sales continued to drop and management failed to retain costs. The fact that the secondary offering came when the stock traded at a 13 year low speaks to the fact that it was unplanned and came in the face of desperation--more likely than not the choice to dilute shareholders was juxtaposed with bankruptcy.

As a pessimist who was willing to give the company the benefit of the doubt I gave the company 5 months from the secondary before it faced similar challenges, which meant that another secondary offering would come at the end of February or at the beginning of March. However I personally didn't believe that the company had that long, and I think that recent developments indicate that my intuition was right. Not only were we given reason to be pessimistic regarding the company's holiday season performance, but we saw cost-cutting measures that reek of desperation, and which can only buy so much time before the company needs to raise substantially more capital.

Let us look at the company's recent developments.

J.C. Penney's Holiday Results

The first is the company's announcement of its holiday sales performance which was released a week ago. Here is the company's statement in full:

JCPenney reported today that the Company is pleased with its performance for the holiday period, showing continued progress in its turnaround efforts. Customers responded well to the Company's offerings this holiday shopping season, both in store and online.

JCPenney also reaffirmed its outlook for the fourth quarter of 2013, as previously set out in the Company's third quarter earnings release dated Nov. 20, 2013.

Of course this doesn't sound bad--management isn't going to come out and say that the company's holiday performance was lousy. But the stock plummeted on this news, which reflected the market's disappointment regarding the lack of specificity in the statement. And we can see why. We have seen statements from the company in the past in which management has said that it is pleased with its performance even when it was lousy. An 'F' student who gets a 'D' might be "pleased" with his performance, but a 'D' is still a bad grade.

Furthermore we have seen statements from management regarding the progress of the company's turnaround when it was in much better shape than it is in currently. Readers of my August J.C. Penney article may recall this statement from CFO Hannah:

Our results reflect the progress we are making on our journey to fix the problems we face and stabilize the business.

He said this during the conference call given for the quarter ended August 3rd, which took place on August 20th when there were 220 million shares outstanding valued between $13 and $14 each. Now there are 305 million shares trading a $7 each.

The fact of the matter is that J.C. Penney's management is now presumed guilty until proven innocent, and if it wants to generate interest in the shares from investors, and if it wants to keep the shorts from circling above it like vultures, it needs to produce concrete figures rather than vague platitudes.

J.C. Penney's New Cost Cutting Measures

J.C. Penney announced several initiatives on January 15th in order to reduce expenses. The first was that it is closing 33 "underperforming" stores hoping to save $65 million annually (about $0.21/share). In doing so it will fire 2,000 employees. I think this is a good idea. However it hardly makes a dent into costs: 33 stores is out of 1,100, and 2,000 employees is out of 116,000.

The second is that it is bringing back commission-based sales, which means that it will pay workers a lower hourly wage and incentivize them to make sales. This will likely motivate some employees and drive them to improve sales, but I think a lot of them who aren't used to working on commission will have a difficult time making the transition and when they see their paychecks shrink after they fail to make sales they will become disenfranchised. Furthermore I think this effort, too, will not really impact the bottom line.

What is more interesting than the material impact of these decisions is the timing. We know that the company is burning through capital quickly, and we can anticipate that holiday sales did nothing to change this fact. We also know that the last time management raised capital it had to given the low share price at the time. I think these actions, which will save a little bit of money, were not done as a part of a well thought out plan, as management's language insinuates. Rather I think management is desperate to raise capital but it wants to avoid issuing more stock, and it initiated the above measures.


From what we have seen recently from J.C. Penney I draw two conclusions. The first is that the company needs capital quite desperately, as is evidenced by the likely poor results from the holiday season and the store closures and commission-based remuneration system that was recently instated. We already knew this, but I think the need is more urgent than most people, including myself, thought even a couple weeks ago.

The second is that management has failed miserably in instituting a "turnaround plan." It keeps referring to this plan and talking about how well it is going, but we see these random insertions into the plan that appear to be desperate and erratic (e.g. the commission-based remuneration system or the secondary offering back in September). Management needs to come out with a straightforward plan that says: "We are doing X in the next 6 months, Y in the next 2 years, and Z in the next 5 years."

Given these points investors should expect more dilution fairly soon if the company isn't forced into bankruptcy before it has a chance to do so.

For 9 months now (since April) I have been recommending that investors short the company's shares on strength. This has worked out extremely well although being a shy short-seller, I have often been optimistic in my upside trading targets. For instance in November, after the November earnings conference call I suggested that traders sell the stock at $12 when it was at $9, but it only went to $10 and change. I think given the recent cost-cutting measures some of the shorts might get spooked and we can see $9 again, but I don't think it can get much higher. Aggressive traders and longs should sell at this point.

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.