Too Little, Too Late
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Truth be told, I love a good turnaround story. I love seeing a company that everyone has left for dead turn in positive results that surprise even the “smartest investors.” However, there is such a thing as too little too late. I honestly believe that is the situation with J.C. Penney Co. (NYSE: JCP).
When the initial hoopla from the hiring of CEO Ron Johnson came out, I was immediately skeptical of the pop in the shares. The issue was not his management capabilities, but the public's perception of the company. I would wager if you ask most people in America about J.C. Penney, their first reaction is not likely a positive one. This company has massive problems that no CEO is going to be able to solve in a short time frame, if at all.
The issues that J.C. Penney is facing are too numerous to cover in this format. However, we'll look at a few issues and see where the company places among their competition. J.C. Penney has been a cornerstone of many enclosed malls for years. Some people might even have fond memories of flipping through the old Christmas catalog and earmarking pages of things that they wanted. However, that is not the day we live in today. The catalog has long been replaced by the Internet, and there are many customers who don't even think of J.C. Penney as a shopping destination. This is the primary issue that the company faces -- their competition represents destination shopping experiences, whereas J.C. Penney doesn't register in most customers thoughts. Let me give you a few examples of other retailers that have positioned themselves better.
The first example is Kohl's (NYSE: KSS), which primarily operates as a destination for mid-priced fashion merchandise. The company has done a good job of mixing reasonable pricing, excellent sales, and their Kohl's cash as a way to drive continued business. Though not a traditional fashion retailer, Target Corp. (NYSE: TGT) is also a direct competitor for J.C. Penney's customer. Customers that used to go into J.C. Penney to purchase clothing now can buy their groceries, household items, and clothing all the same time from Target. Given the fact that the company has increased awareness of their value-priced clothing brands, many shoppers regularly check the store for their wardrobe needs. Operating at the higher end of the spectrum is Macy's (NYSE: M). Where this competitor stands out is offering a greater selection of high-quality items, so shoppers are willing to spend a little more for better merchandise.
You can see that between these three competitors, Target takes the low-end, Kohl's takes the mid-priced customer, and Macy's takes the high-end customer. While this doesn't represent all of J.C. Penney's competition, you can see there isn't a category of consumer that the company can attract that isn't already being catered to by another strong retailer. It is no longer a question of getting new customers for J.C. Penney, it is a question of stealing loyal shoppers from retailers that they are already happy with. As proof that the challenge J.C. Penney is facing will not be simple to overcome, one only needs to look at the company's most recent earnings report.
This is one of the few earnings reports that I've seen where there really was not one number I could find that painted a positive picture of the company. With total sales down 20.1% and a loss of $.25 per share, this was just the beginning of the painful numbers for investors. The two most discouraging numbers have to be comparable store sales and Internet sales. With comparable sales down 18.9% and Internet sales down 27.9%, the company is selling less to customers in the store and online. Even with struggling retailers, usually one of these two measures comes out positive. In addition, the company had to cut its gross margin to get these results, with gross margin coming in almost 3% below last year's number.
The company's financials paint just as bleak of a picture. J.C. Penney spent nearly 50% of their cash and cash equivalents covering their negative cash flow for the quarter. Operating cash flow started at negative $577 million and the company spent another $107 million on capital expenditures. The combination of these two numbers caused cash and cash equivalents to drop to $839 million. With long-term debt staying flat at $2.871 billion, this retailer has a much weaker balance sheet than just three months ago. The company discontinued its dividend, which is expected to save about $175 million. However, according to the report, additional inventory markdowns and restructuring charges may be necessary. Amazingly, the company made the comment that they are, “confident in our vision to become America's favorite store.” While it's good to hear management express confidence in the company's future, this statement rings very hollow to me.
The bottom line is J.C. Penney does not have a competitive advantage over any of their competition. That alone is the reason to stay away from the stock. In fact, any of the previously mentioned competitors seem like a better option. Kohl's pays a 2.6% yield, is selling for less than its expected growth rate, and has beaten earnings in three of the last four quarters.
Macy's would seem to be a good option as well. This company pays a 2.2% yield, sells for less than its expected growth rate, and has been beating earnings estimates on a regular basis.
Where Target is concerned, while there's been a lot of commentary on the challenges that the retailer faces from Amazon.com, many of these issues are overblown. The company offers value-priced fashion that is not practical to buy online, is expanding their grocery and household items selection, and is a one-stop shop for many Americans. With a 2.3% yield and expected earnings growth of just over 11%, the company is yet another retail stock that looks better than J.C. Penney.
While it's admirable that J.C. Penney management believes in the concept, it's too little too late.
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