Got Some Time and a Strong Stomach? Try J.C. Penney on for Size
Tim is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Though not a contrarian by nature –oversold but solid companies selling at a discount are generally much more attractive – J.C. Penney (NYSE: JCP) offers investors with gumption and an intriguing storyline. It’ll require some faith and patience, but all is not as dour as it appears. Of course shareholders are most certainly fuming that anyone could suggest such a thing with the stock beaten down as it is – and no one would blame you – but take a look at this from a slightly different perspective.
A Monumental Transition
CEO Ron Johnson and his team – as investors are well aware – have taken on a monumental task. Not only with the new pricing structure – that in and of itself is an on-going process of educating customers - but essentially re-inventing the entire enterprise.
Inventory control was the bane of the company’s existence – much like the problems former retail giant Sears (NASDAQ: SHLD) continues to struggle with. For the retail industry inventory control is an absolute must. The lack of a sound inventory management plan puts pressure on margins, negatively impacts expenses and is (rightfully) viewed by shareholders as a poor reflection on management in general. In the case of Sears, the view of management is warranted as evidenced by its lack of direction, refusal to invest in their stores and what amounts to the hosting of asset fire sales. Here’s a bit more on that fiasco if you're so inclined.
Sales for the “new” J.C. Penney were always going to be a while in coming – even the most pessimistic of investors had to admit that - but Mr. Johnson concedes they’re taking longer than expected to ramp up.
The Results
Not surprisingly the recent fiscal quarterly results were painful. One of the many distressing results were same store sales dropping nearly 19% - which was almost as bad the decline in total sales of 20%. Ouch. It should be noted that some of the poor sales results were due to getting out of the outlet business, but bad is still bad. Speaking of which, fiscal Q1 internet sales dropped 28% to $271 million.
Remember the inventory problems and the impact on margins? At first glance J.C. Penney would seem to have been hit hard in this area as well. Compared to last year’s 40.5% gross margin, fiscal Q1 of 2012’s 37.6% spread is tough to swallow. But there’s a caveat to this particular result that bears mentioning. In an effort to clear inventory and better manage this critical part of the business, the company – as you’d expect – marked down older items dramatically. And – every bit as critical - was the impact of a inventory reserve totalling $53 million relating to the inventory reduction strategy. Add that back in and the margin pops to 39.3%. Pretty? No, but not nearly as bad as it appears at first glance.
A Ray or Two of Hope
With all the above, what could possibly be attractive about J.C. Penney right now? A legitimate question – particularly when there are other opportunities that appear more attractive. Macy’s (NYSE: M) has several months of same store sales increases under their belts and is a great value relative to the industry. Saks (NYSE: SKS) has been treated fairly rough these past couple of days after announcing their own earnings, but there are other factors that should be considered before denouncing the company after what was actually a solid quarter.
As for J.C. Penney, first and foremost is the leadership and direction CEO Ron Johnson provides. It’s clear he has his entire team on the same page and heading in the right direction. J.C. Penney’s certainly doesn’t give off the same sense of being a rudderless, meandering company like Sears does. Need proof? Based on steps already taken and expectations for the balance of 2012, J.C. Penney will shave approximately $900 million in expenses by year-end - a year ahead of schedule. That’s a great indicator of a well-run company implementing a sound strategy – a company has everyone from senior management to frontline employees focused on success.
Though not great news for current shareholders, J.C. Penney’s decision to end its dividend payout will help almost immediately. The approximately $175 million in savings will go directly to implementing the company’s aggressive transition.
From a 30,000 foot view the environment is right for a turnaround as well. We continually see generally positive economic trends – almost all of which translates to good news for the retail industry. Consumer confidence, spending, housing numbers, employment – you name it.
When it’s all said and done contrarians, it boils down to this – do you believe in Ron and his team's plan? If so – and you have time and are willing to assume some risk (and what contrarian isn’t?) – J.C. Penney has the potential to pay off big.
timbrugger has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
