The Day Ahead: The Penney Drops

 | Apr 10, 2013 | 8:00 AM EDT
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I am in a really foul, rip-another-person's-throat-out type of mood today, a mood that's probably similar to the one felt by those who are still holding J.C. Penney (JCP) from January 2012 because of Buy-rating-loving analysts.

While part of it could be attributed to the personal workload, the real deal is that investors didn't receive the information they needed on J.C. Penney. Hence, I am upset. This debacle is arguably a top three-story in 2013 and one that warrants maximum attention. Even if you don't own J.C. Penney shares (who else is left anyway?), the company's precarious position could have ramifications for other consumer companies.

For instance, what if J.C. Penney were to liquidate, leaving thousands of people without a job across the U.S.? Think that won't affect the Campbell's Soup (CPB)? Or how about if J.C. Penney starts promoting so aggressively under new-old CEO Mike Ullman that it logically crushes the Kohl's (KSS) you are praying is taken over in a LBO transaction because it's all alleged to be massively undervalued?

Mall REITs? A J.C. Penney asset fire sale would ripple throughout the income statements and balance sheets of these companies (and perhaps their debt, which is astronomical).

No apologies for the foul mood. I saw minimal dot-connecting on J.C. Penney on Tuesday and found it to be a disservice to the average investor who is just yearning for education and protection from unforeseen calamities. To top it off, this was a development that had serious indications of happening months earlier, and therefore a basic level of preparation should have been on the ready.

Instead, we watched the sell-side act as flimsy in its opinions as a paper airplane. (Memo: More than 60% of the sell side gave J.C. Penney shares a Buy or Neutral rating, and there was only one J.C. Penney report published before 7 a.m. EDT on Tuesday -- horrible.)

Ullman may be a friendly face to those analysts who are loving this decision. However, I believe Ullman offers the kiss of death wrapped in a smile and a balding head. Here's why the stock gave up ground on his hiring:

  • Ullman is the king of the promotion. One has to believe that heading into the holiday season, he will ramp up discounts to lure back disenchanted shoppers. Why is this profoundly bad? J.C. Penney has already plowed tons of shareholder funds into shop-in shops (free cash flow in 2012 ate up that which was earned in the prior four years), so an environment of Ullman's 1980s promotional strategy sets the stage for poor returns on shop-in shop investments right out of the gate.
  • Ullman is not the long-term solution for J.C. Penney. In my view, he is being tapped to stabilize the ship, slow down the pace of change and then hand off the baton (a sleeper pick could be Brendan Hoffman at Bon-Ton (BONT), a young executive who turned around Neiman Marcus and Lord & Taylor and is ready for the heavy load of driving J.C. Penney). Nonetheless, there is a huge problem, in that for the next 30 days J.C. Penney is a company in crisis as Ullman reviews Ron Johnson's strategies and executive team and makes the calls to vendors. A stale J.C. Penney deserves to lose more market cap, as it's burning through oodles of cash, plain and simple.
  • Johnson's exit signals a lack of board confidence in J.C. Penney winning the Martha Stewart Living (MSO) case. If that is the case, J.C. Penney essentially will have executed a massively flawed plan that tied up money in unproductive inventory.
  • J.C. Penney could bring in Mickey Drexler to run the company, but that there is a large legacy pension cost issue (which goes undiscussed).
  • One would have to think bids for the company become public shortly (before the end of 2013).
  • First-quarter financials are likely nowhere near internal plan.

As for the Market...

The market was in fact open yesterday, and companies not named J.C. Penney and Herbalife (HLF) traded. Alcoa's (AA) useless earnings report was somehow spun into a positive, ditto China inflation data (hmm, I thought below-plan price increases were a negative thing) and a Bernanke speech that wasn't focused on monetary policy.

If you look sector by sector, there are valid enough reasons to approach earnings madness with a higher weighting of cash than you had in March. I am not particularly enthusiastic on global macro trends, especially in the U.S., which is demonstrating earlier-than-the-norm seasonal weakness.

To become more constructive, I need to observe stronger buying on bruised leading sectors. Or we must see that single bellwether report that serves to justify the P/E multiple expansion we have had. Remember, a greater number of companies in their respective sectors have to be outperforming their plans at this point, a combination of improved pricing and healing or accelerating global end markets.



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