patrick.net

This is a stock I have been following closely for a long time. Bought when Soros bought and sold before the last earning and made 40% in one month. I have been thinking about them a lot lately and now recommend a strong buy. Here’s a summary of my reasoning and material background.

Who’s long?

Soros and Ackman. A 25% stake held by two of the most respected investor is a good reason for me. Ackman changed my family when (I mom, brothers and close friends, in law) placed a bet on GGP when they announced bankruptcy and promptly went on for a fourty bagger in 4 years using the same reasoning applied by Ackman (real estate was worth too much). If there is a question that asks who is your favorite author, it would be Soros (albeit someone writes on his behalf)

JCP Background (Permanent of Temporary problems)?

JCP has a 100+ year background. 1,100+ department stores scattered throughout the United States and an online store via JCP.com. Over the years, they used their equity to purchase 400+ stores and own the HQ and distribution facilities. The non-owned stores are likely on long term lease with long term options and likely very favorable. In a nutshell, their cost structure is as favorable as any retailer out there. Basically at a market cap of 3.7B, you are getting Penney at less than 4M per department store and $4sale/market cap and an enterprise value above shares (if you count the true market value of real estate that is not marked-up on the balance sheet). The market is pricing Penney like it would be dead (which may or may not be the case). So obviously understanding whether Penney’s problems are permanent vs. temporary is of great interest to me.

The demise of JCP

The great recession impacted everyone including JCP. It hit JCP consumers especially hard unlike Macy’s whose customers are more upscale and wealthy. Unlike the rest that recovered from the recession, JCP sank further and is especially painful given the bull market in 2009-2013.

Long story short, Ackman kicked out Ullman and Ron Johnson was brought on board. Ron brought his own team from Apple and installed his expensive and risky vision and likely created a hostile work environoment bewteen Ullmans and Johnson's people. The strategy employed by JCP should be studied by every business school now in America as it is fascinating. (When I was in college, Dell and IBM was the study case, but now, JCP and BBRY would be my study). The huge difference between Apple retail and JCP retail is about 1M SKU’s and customers that seek the deals. Apple sells Iphone, Ipad, Ibook for the same $599, 1,099 price and sells itself. JCP is a completely different beast. Ron Johnson’s fit was a disaster and under his watch, burned through 1B in capex and burned through another 1B in operating losses and alienated customers. Revenue went from the 17B’s to 12B, practically unheard of in the retail industry to fall that far that fast. SSS was negative 25%. The financial metric was an outright disaster and the PR was a disaster. Further, Johnson got into some legal issues with Martha Stewart and Macy. If there was ever a board you want to be a fly on the wall, JCP was the one to see what the Board asks and how Johnson responded. In March, Johnson out and familiar face Ullman in. Penney was described as a disaster, mess and much worst. Soros buy.

Here was some of JCP’s problems:

•Fair and square pricing in lieu of discounts on top of discounts. This was a bad maneuver. Customers like to feel like they got a deal and there are customers that buy and not look at price tag. In the first category, you lose customers who are trained on feeling like they got a deal, in the second category, you underpriced the product and lost revenue. The retail world sells inventory in full retail price when it is fresh off the shelves and discount it to get rid of it. It is the straightforward and proven way to manage inventory. When you sell 100K different things, that is the only way to go. This is a temporary problem not a perm problem.

•Cap-ex and shop in shop. In all fairness, Johnson was either going to be a hero or a zero. The shop in shop concept is actually well deployed in places like Asia and successful, it gives branded retailers incentive and push to partner with JCP. Ullman already started with the Sephora make-up store and by all accounts, it was successful. Johnson pressed the button to cap-ex the home store, clothing store and children’s store. It’s probably one of the biggest riskiest bet for retail. (huge cap-ex, taking out floor space and sacrifice performance and you have customers that may not accept the new brands). The dumped St. John which was a basic men's category which was a huge mistake.

A lot of the cash burn and SSS was expected. That strategy is yet to be determined. I have been visiting JCP a lot lately in different areas of town and observing traffic and conversion. I went on mother’s day and father’s day to further look at foot traffic and conversions as those are key dates to department stores. It’s been mixed.

Overall, I’m a believer in the strategy. Once the home store are all in business, the Disney stores comes in for back to school and all the shops are in place for the critical holiday season, JCP may be in business and I would not be surprise they can get back from 12B – 17B. It takes 6 months of planning to deliver results as decisions are made now for the critical holiday month and JCP is as focused as it has ever been in 100 years. lol A good friend of mine works at Levi’s and they are pleased with the Levis store at JCP and am working hard to increase traffic there specifically. More so than selling more jeans to Macy's as they have more reasons to see JCP do well than Macy's.

• Win back lost customers: I don’t think consumer hold any grudge against JCP. In the end, JCP is an anchor store on one of the wing. They’ll come as long as the consumer confidence and economic environment is fine and get used to shopping by brand instead of category. bring back what works for the older shoppers and continue to engage the younger shopper it was trying to appeal to. It’s a matter of getting the right product at the right price and become cusomer focused. It’s not terribly new anyway as Macy’s have their branded stores anyway.

• Retail climate. JCP is shielded from Europe and Asia so their health is based solely on the American consumer and betting on the american middle class. Online stores have been eating everyone but I don’t think malls are going away, just need to be righsized. It helps JCP that fair market act are coming on board (possibly) and Obamacare penalty provision are delayed another year. The US tax system,(inluding locally) and policies will be generally supportive of domestic business that hires American workers.

So I’ve convinced myself to buy JCP again (thinks the big issues are temporary). It is a great risk vs. reward play. I really think by back to school and this Christmas, JCP will be clearly trending up again. They have a lot of press lately and I think they have a legit shot once all the stores, marketing, promotions, brands are finally on line at the same time (by back to school). Downside $12 by December and upside $30 if it is clear their turnaround efforts are (not)working and funds will come on board big time.

I am long @ a tad under $17. (Sold for $13 when Ackman was out) Good luck.

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