JCP, Speculative Play or Come Back in the Making?

Adrian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Editor's Note: Michael Francis is no longer with J.C. Penney. This version has been corrected.

Although I must recognize that at first, when I started seeing the headlines regarding the performance of J.C. Penney (NYSE: JCP), I was more inclined to short the stock thinking that the company was over for good. That changed after I placed the stock under my radar and looked at it more closely for signs of improvement or a major catastrophe.

After at least 2 months since I started following this company I decided to go through the 2011 10-K and the latest 3 quarterly results to get a better picture of the fundamentals of the company and try to understand the transformation it's going through right now. In order to be able to understand it better I visited one of their stores in south Texas and I was quite impressed with the changes I witnessed at this particular location.

Here are my thoughts:

Management.

J.C. Penney in its 2011 10-K has listed 7 executive officers of which 4 have barely joined or started serving in their new roll within the last 18 months.

Ronald B. Johnson who is now the CEO of the company came from Apple on November 2011. Before being the senior VP of retail at Apple, Mr. Johnson was a senior VP of merchandising at Target.

Michael W. Kramer the COO started on his roll on December 2011.

Daniel E. Walker has served the company as a Chief Talent Officer since November 2011.

To sum it all up, management is kind of new to the company, but not at the job they’re doing. In my opinion we have to give them time to transform the company and to make it more efficient and profitable.

Fundamentals.

Here the story turns more interesting. While management has insisted in highlighting the improvement within the new shops (as they are calling them), it is of great concern that fundamentals have been deteriorating at a very rapid pace over the last several quarters now.

Let’s analyze the results of operations (income statements) for the last five years first:

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p><strong>2011</strong></p> </td> <td> <p><strong>2010</strong></p> </td> <td> <p><strong>2009</strong></p> </td> <td> <p><strong>2008</strong></p> </td> <td> <p><strong>2007</strong></p> </td> </tr> <tr> <td> <p><strong>Revenue</strong></p> </td> <td> <p>$17,260</p> </td> <td> <p>$17,759</p> </td> <td> <p>$17,556</p> </td> <td> <p>$18,486</p> </td> <td> <p>$19,860</p> </td> </tr> <tr> <td> <p><strong>Operating (loss)/Income</strong></p> </td> <td> <p>(2)</p> </td> <td> <p>832</p> </td> <td> <p>663</p> </td> <td> <p>1,135</p> </td> <td> <p>1,888</p> </td> </tr> <tr> <td> <p><strong>Net (Loss)/Income</strong></p> </td> <td> <p>(152)</p> </td> <td> <p>378</p> </td> <td> <p>249</p> </td> <td> <p>567</p> </td> <td> <p>1,105</p> </td> </tr> <tr> <td> <p><strong>EPS</strong></p> </td> <td> <p>(0.70)</p> </td> <td> <p>1.59</p> </td> <td> <p>1.07</p> </td> <td> <p>2.54</p> </td> <td> <p>4.90</p> </td> </tr> </tbody> </table>

In millions except per share data.

This kind of information is what has the investors thinking whether or not the strategy is working. If we consider the dramatic shift on EPS from a nice $4.90 back in 2007 to a loss of ($0.70) on 2011 and compare it to the decline in sales equivalent to 13% during the same period we can see that there is a problem regarding margins. However, let’s not forget that capital expenditures are being made do to the transformation and management has said that for 2012 it will be around the $850 million and another $800 million or so for 2013. So we can expect margins to be quite low for the next 3 of 4 quarters.

When it comes to the balance sheet, it is even scarier than the income statement. I have gathered some key metrics for you to consider.

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p><strong>4Q10</strong></p> </td> <td> <p><strong>1Q11</strong></p> </td> <td> <p><strong>2Q11</strong></p> </td> <td> <p><strong>3Q11</strong></p> </td> <td> <p><strong>4Q11</strong></p> </td> <td> <p><strong>1Q12</strong></p> </td> <td> <p><strong>2Q12</strong></p> </td> <td> <p><strong>3Q12</strong></p> </td> </tr> <tr> <td> <p><strong>Book Value</strong></p> </td> <td> <p>$23.07</p> </td> <td> <p>$20.50</p> </td> <td> <p>$21.74</p> </td> <td> <p>$21.20</p> </td> <td> <p>$18.57</p> </td> <td> <p>$18.03</p> </td> <td> <p>$16.74</p> </td> <td> <p>$15.96</p> </td> </tr> <tr> <td> <p><strong>Cash per Share</strong></p> </td> <td> <p>$11.08</p> </td> <td> <p>$7.62</p> </td> <td> <p>$7.17</p> </td> <td> <p>$5.09</p> </td> <td> <p>$6.37</p> </td> <td> <p>$3.84</p> </td> <td> <p>$4.05</p> </td> <td> <p>$2.39</p> </td> </tr> <tr> <td> <p><strong>Debt / Cash</strong></p> </td> <td> <p>2.90</p> </td> <td> <p>4.33</p> </td> <td> <p>5.00</p> </td> <td> <p>7.65</p> </td> <td> <p>4.92</p> </td> <td> <p>8.47</p> </td> <td> <p>8.04</p> </td> <td> <p>13.88</p> </td> </tr> <tr> <td> <p><strong>Debt / Equity</strong></p> </td> <td> <p>1.39</p> </td> <td> <p>1.61</p> </td> <td> <p>1.65</p> </td> <td> <p>1.84</p> </td> <td> <p>1.85</p> </td> <td> <p>1.80</p> </td> <td> <p>1.95</p> </td> <td> <p>2.08</p> </td> </tr> </tbody> </table>

As you can see in the table above, there are serious signs of deterioration in the balance sheet. Cash is quickly running out, it has lost $8.69 per share or 78% in less than 2 years. Although the company has stated that they have a credit line of 1.5 billion and currently have not used it at all, this can give us an idea that management may have to use that credit line to keep operating in the short term and fulfill the transformation process.

Equity is also eroding (not as fast but still) from the company. In the debt-to-equity ratio you can see a significant increase over the last 8 quarters. This is not good; I consider a healthy balance sheet when there is enough cash in hand to cover the debt, even though management has said that most of the debt is not due in the short term.

Strategy.

Changing the layout of the stores and creating a new and improved shopping experience is something we will enjoy once its finalized. Not having to go through mountains of merchandise and cluttered stores is definitely something to look forward to. Also, I really love the fair and square pricing, since collecting coupons and putting them on my wallet is not something I like doing at all. This has me completely interested and I can say one thing for sure, my family’s Christmas shopping will be made at JCP.

In my opinion, the strategy and vision of Mr. Johnson is good and will pay in the long term for those who are willing to endure a few more quarters of pain. I don’t expect to see any improvement in those metrics that I’ve mentioned before at least for another 2 – 3 quarters. Remember there are barely 10 shops that have been introduced of the 100 that are planned, so expect more heavy capital expenditures in the months to come.

Projection.

I believe it is too early on this turn around to be able to project anything. If you are thinking about taking a position on this stock I will advise you to do it as pure speculation, there are many things left for management to do in order for this ship to avoid wreckage.

Two more quarters should give us a better sense of how the new concept is working and if we can expect a return, but until then please be careful.

 


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