An Inside Look at the New Retail Strategy at J.C. Penney (Part 2)

As was discussed yesterday, the much-talked about turnaround strategy at J.C. Penney (JCP), being led by Ron Johnson, is going to take a lot longer than many initially thought. Renovating two-thirds of their store base will take 3-4 years. Getting customers to understand and appreciate their new pricing model will take time, if it happens at all. If you contemplate the finished product in 2015, as Johnson has outlined it, the new JCP is likely to be very unique and intriguing for a large subset of shoppers. One hundred specialty shops, with large well-known brands such as Nike and Martha Stewart, connected by a “street” complete with food and beverage stations, comfy couches, free wi-fi, seasonal services such as Santa and gingerbread cookies for the kids in December or yoga classes and smoothies for moms to kick off the new year… it sounds great in theory. And that’s just it, in theory.

The end product won’t be completed for three more years. Until then, the stores will constantly have areas being boarded up and redone. With so many other choices in the typical mall, will shoppers leave JCP and have little reason to come back, even if the store in 2015 looks cool? And that’s another problem… the cool factor. It was obvious when I was at JCP on Monday that a large chunk of their core customers are women 50 years and over. Is that customer going to care that there is free wi-fi or nice couches in the store? Will they shop for denim fits and dyes at an iPad station? Are they going to warm to the RFID-enabled self-checkout kiosks that Johnson is planning? Sure, placing your shopping bag on the table and having the checkout station automatically read its contents and ring up the purchase is nice (all you have to do is swipe your card, no bar code scanning required), but is that too tech-heavy for the older generation? Can’t you envision the line at the cashier backing up pretty quickly if there is only one actual human operating it?

It seems this new prototype JCP store is geared towards a younger audience and I am not sure that crowd will head over to JCP even if it is designed for them. Again, you might have 100 shops in your JCP, but there are at least that many in the mall itself, and that is where most of these people already loyally shop. He won’t say it directly, but Ron Johnson probably knows that he really is launching a completely new store here, and will have to market it heavily so people know it exists and will give it a try.

Which brings us to the timing aspect of the investment story for JCP shares. The stock went from the high 20’s to the low 40’s when Johnson was hired, merely based on his previous retail successes. After Q1 2012 same-store sales dropped nearly 20%, the shares cratered to below $20 each. They have since rebounded to the mid 20’s, as investors hope for a rebound as more newly renovated shops are added. Second quarter comps fell by more than 20%. I don’t think an IZOD shop and a JCP house brand shop are going to move the needle in Q3, so I would expect similar results again this quarter. Whether they are down 16%, 20%, or 24%, though, is anyone’s guess.

When we get to the holiday season, then it really gets interesting. Wall Street analysts are an overly optimistic bunch, and typically project sales improvement slowly over time, regardless of the situation. The same is true of JCP today. Fourth quarter sales estimates right now are for a drop of 11% year-over-year, so the consensus is that revenue losses will be cut in half within a couple of months from now. Possible? Sure, maybe better sell-through of Levi’s jeans, from the new, fresh shop design, will offset a lot of the negatives from the older areas of the store.

But what if the holiday season for JCP actually gets worse? After all, they are trying to cut down on sales and offer everyday low prices. If customers balked at buying full priced items (regardless of the actual price level) over Memorial Day, why would their buying patterns change in November and December? In fact, would they not be even more inclined to look for sales over the holidays? JCP cutting back on sales should hurt them the most when everybody else is running Black Friday doorbusters. JCP already had a TV commercial making fun of long lines outside stores at 4am. Now they will be competing against them. How will sales be on Cyber Monday at jcp.com? Probably worse than macys.com and kohls.com, right?

I know it is not the consensus view, but one of the reasons I have not bought a single share of JCP is that I think it is reasonable to think sales could get worse, not better, during the fourth quarter. If the first nine months of 2012 see sales declines of 20%, on average, why couldn’t a lack of Black Friday and Cyber Monday doorbuster specials result in a 30% decline during the ever-important holiday shopping season? Seems possible, in which case investors are in for a rude surprise when Q4 sales results come out early in 2013. Another round of selling may very well occur.

At that point, though, maybe it will be a better time to dip one’s toe in, if in fact you want to place a wager on the long-term future of JCP. Next year the company will be lapping an absolutely horrible financial performance from 2012. The bar will be low and expectations will be uninspiring. Even if 2013 brings more of the same; more renovations and little in the way of increased customer excitement, it is hard to imagine sales falling another 20% from 2012 levels. While a meaningful turn might be a ways off, 2012 might still mark the bottom for sales losses, and for the stock. And we all know the stock market is forward-looking, so even if we won’t see material improvement until 2014 or 2015, investors will bid up the stock ahead of time, just like they have in recent weeks on hopes that things will get better very soon.

Full Disclosure: No position in any of the companies mentioned at the time of writing, but positions may change at any time.

 

An Inside Look at the New Retail Strategy at J.C. Penney (Part 1)

On September 1st, J.C. Penney (JCP) debuted more new “shops,” bringing it about 10% of the way through a transformation plan aimed at having 700 of the chain’s 1100 department stores offer shoppers 100 distinct “store within a store” experiences by 2015. My wife and I used part of our Labor Day holiday to do some market research at a local Portland mall and check out the progress at one of these renovated JCP locations.

I have been doing a fair amount of work on JCP lately, trying to figure out if it is a turnaround story I want to play or not. For me, there are three essential questions to ask when making this kind of investment decision. One, do I want to make a bullish bet on a JCP turnaround under new CEO Ron Johnson? Two, at what share price do I feel the risk-reward is attractive enough for the stock? And three, since this is a multi-year turnaround story (renovating 700 stores while they remain open is not easy), at what point in the process would it make the most sense to start buying?

With much of the valuation work done already from my office, my in-person store visit on Monday was more about checking out how the renovations looked and how shoppers were responding to them. I went to one location, in the morning, on a holiday, so this is by no means enough observation to draw strong conclusions about customer traffic, but it was enough to get an idea of where these stores are heading over the next few years.

As soon as you walk into the store, you see the original “store within a store” concept, Sephora, that JCP introduced even before Ron Johnson took over as CEO:

The Sephora stores inside J.C. Penney have done very well. They look identical to actual Sephora stores, just with fewer square feet. The successes JCP has seen so far are often cited as a reason why the concept of converting the entire JCP store into dozens of specialty shops has huge potential. I would agree with that assessment, but it completely depends on what products you are selling. Sephora is very popular right now, so it would be hard for it to do poorly. What about other brands? That is the big question mark at this point.

Which brings us to the new shops JCP unveiled this month; IZOD, Liz Claiborne, and JCP (a generic house brand for basics). These are in addition to those already in place; Sephora, iJeans by Buffalo, Levi’s, The Original Arizona Jean Co, and MNG by Mango. You may have noticed something odd about that list already, but we’ll get to that shortly. For those who have not been in a JCP lately, here is what these new shops look like:

IZOD

Levi’s

JCP

Notice there is nothing earth-shattering or particularly new here in terms of product. What they have essentially done is group product by brand and install upgraded fixtures and displays, so you feel like you are shopping at a smaller Gap or J Crew store within the mall, not at the enormous J.C. Penney anchor location. For instance, here is what most of the store’s floor at JCP still looks like:

Obviously, cleaning up the stores by making them less cluttered, adding better lighting, and displaying the clothes more effectively is probably an investment worth making, if you are trying to revamp a department store and position it for long-term survival. Still, the early response by customers has been poor. Making the stores look nicer has not counteracted the negative impact from JCP’s decision to reduce the number of sales they run and opt instead for everyday low prices on most items. Rather than paying $25 for a sweater originally marked $75 or $80 (although nobody ever paid that price), JCP has faith that shoppers will make the same purchase, even if it is marked $25 from the start with no discount. Shoppers are balking. The first quarter after the change (Q1 2012), sales dropped 19%. Last quarter they fell by 22%. I don’t think there is reason to think the current quarter will be much different.

The pricing issue was something I made a point to watch for during my store visit. Again, it was before noon on Labor Day, so there was not much traffic in the stores. However, you may have noticed that there weren’t any shoppers in the photos above. I was not the only one in the store, and I did not ask anyone to get out of the shots. So where were they? Well, look at that, there they are:

The clearance rack. Despite JCP’s goal of getting 80%+ of their sales from full price merchandise with their new everyday low price strategy, the store still has product it needs to move quickly, so the clearance racks have not gone away. Interestingly, the signs on these racks do not simply say “clearance” but rather “clearance – $5 and up.” Why put “$5” on the sign, which just signals you have really cheap sale merchandise (and gets you thinking that full price may be overpriced)? I don’t know. It seems counter-productive. My wife even mentioned that she saw a $20 sweater that she liked, but since it was positioned close to the sale racks, she instinctively looked up to see if it was on sale. When it wasn’t, she questioned whether people would think $20 was a good enough price (even though a $20 sweater, on its own, is quite inexpensive). This is what JCP is facing with their new strategy.

Even bigger than pricing strategy is that shoppers are still gravitating to the sale racks, even with these new, upgraded specialty shops. That is where the customers were on Monday, which jives with the trend they have seen so far this year; less traffic, fewer sales, and lower gross margin on each sale. Shoppers are still fixated on sales, and if you don’t have as many, they will either leave the store, or only buy the cheaper stuff. Not a good recipe for a retail turnaround (given that JCP is trying to do the exact opposite).

After my in-store visit to JCP this week I was hoping to shed some light on the first of three questions I mentioned at the outset of this post; do I want to make a bullish bet on a JCP turnaround? When you listen to Ron Johnson articulate the ideas he has, they make sense and you can’t help but be inclined to think he just might make it work. And he might. However, I had mixed feelings after seeing the store. The shops look nice, but so far customers have not responded, in large part due to pricing. They still flock to the sale racks.

I think JCP can fix this problem to a large degree by offering unique product (like Sephora) in order to differentiate themselves from other stores like Sears, Kohls, and Macys. I am not sure that the Levi’s, Arizona Jean Co, and JCP brands do that. Even Liz Claiborne, which is exclusive to JCP, might not be different enough from other similar brands found in competing stores to make people want to go to JCP first.

Not only that, but did you notice the odd choice for the initial set of new specialty shops? Levi’s, the Original Arizona Jeans Co, and iJeans by Buffalo are all among the first eight shops. How many choices of jeans does one need? And is that really the best way to use their concept, by duplicating product so much? And you know there are other brands of jeans in the store already (I saw Lee jeans right next to the Levi’s shop, for instance). In fact, while we were there my wife overheard a female shopper ask for some help finding a pair of new jeans. The employee walked her over to the Levi’s shop, but then told her, unfortunately, that there were jeans scattered around the store, so although this was the best place to start, she would have to walk the entire floor to see everything they had.

That type of shopping experience is exactly what you would expect from a large, disorganized department store; the exact model JCP is trying to get away from. If you are aiming for a wonderful shopping experience (Ron Johnson is aiming low — trying to becoming “America’s favorite store”), you probably don’t need three denim brands in your first eight shops. And if you do, at least put them close together and remove the other jeans from the rest of the store. First impressions are everything, as new shops are going to be added periodically over the next three years.

As you can see, this is still very much a work in progress. So, I remain skeptical and will likely want to see some proof of changing customer behavior in future quarters before I take a bullish stance. Right now it is more about the potential for success (if executed better in the future) and less about solid progress thus far.

More thoughts on JCP are coming shortly, so stay tuned.

Full Disclosure: No position in any of the stocks mentioned at the time of writing, but positions may change at any time

Consumer Debt Paydown Crimps GDP Growth

It’s election season so both candidates would love for you to think that the POTUS has a lot of control over economic growth, but this week we got a report that sheds light on one of the major reasons the U. S. economy is growing at around 2%, down from its long-term average of around 3% per year. The New York Federal Reserve reported that credit card debt balances last quarter dropped a $672 billion, a level not seen since 2002. It also marks a 22.4% decline from the peak we saw in the fourth quarter of 2008.

So how exactly has this de-leveraging trend negatively impacted GDP growth? Well, consumer spending represents about 70% of GDP, so a drop in credit card balances of $200 billion over the last few years represents a lot of money that was sent off to pay bills, not spent on goods and services. Toss in another $100 billion of spending that would normally be incremental over that time period due to overall growth in the underlying economy, and you can see that about $300 billion of consumer spending has been absent from the system, compared to what would have been normal.

With annual U.S. GDP at around $15 trillion, this consumer credit card de-leveraging represents about 2% of GDP growth lost. Over 3-4 years, that comes out to about 0.5% GDP impact per year. In a world where GDP growth has dropped a full percentage point from its long-term normalized level, consumer debt repayments account for a major portion of that slowdown. You aren’t likely to hear much about that on the campaign trail, but politicians rarely deal with facts and truths when it comes to hot-button issues like the economy.

Bubble Bursting 2.0 (Part 2): Isn’t Groupon Worth Something?

Last November, in a post entitled “Numbers Behind Groupon’s Business Warrant Caution After First Day Pop”, I cautioned investors that the IPO of daily deal leader Groupon (GRPN) looked sky-high at the initial offer price of $20 per share, which valued the company at an astounding $13 billion:

“It is not hard to understand why skeptics do not believe Groupon is worth nearly $13 billion today. To warrant a $425 per customer valuation, Groupon would have to sell far more Groupons to its customers than it does now, or make so much profit on each one that it negates the lower sales rate. The former scenario is unlikely to materialize as merchant growth slows. The latter could improve when the company stops spending so much money on marketing (currently more than half of net revenue is allocated there), but who knows when that will happen or how the daily deal industry landscape will evolve in the meantime over the next couple of years.

Buyer beware seems to definitely be warranted here.”

A few things have happened since then. First, Groupon has cut back on marketing spending and is now making a profit (free cash flow of $50 million in the second quarter). Second, the post-IPO insider lockup period has expired, removing a negative catalyst that the market knew was coming. Third, and most importantly, Groupon’s stock has plummeted from a high of $31 on the first day of trading ($20 billion valuation) to a new low today of $4.50 ($3 billion valuation).

Here is my question, as simply as I can put it; “Isn’t Groupon worth something?” The stock market seems to be wondering if many of these Internet IPOs will exist in a few years. Today’s 8% price drop for Groupon was prompted by an analyst downgrade to a “sell” and a $3 price target. Here is a company with $1.2 billion in cash, no debt, and a free cash flow positive business that will generate over $2 billion of revenue this year. That has to be worth something. How much is another story.

I would argue that it is too early to write off companies like Groupon as being “finished.” It is far from assured that they will be around in 3-5 years, but many of them have huge cash hoards ($2 per share in Groupon’s case), no debt, and a business that is making money today. My most recent blog post made the point that many of these Internet companies are going to survive, and in those cases bargain hunters are likely to make a lot of money. Will Groupon be one of them? I don’t know, but if an investor wanted to make that bet, at $4.50 per share, they are paying about $1.8 billion ($3 billion market value less $1.2 billion of cash in the bank) for an operating business that is on track for more than $2 billion in sales and $200 million in free cash flow in 2012. And who knows, with this kind of negative momentum, the shares could certainly reach the analyst’s $3 price target in a few more days.

Bottom line: these things are starting to get pretty darn cheap. If they make it, of course.

Full Disclosure: No position in Groupon at the time of writing, but positions may change at any time.

J.C. Penney Stock: Back to Earth

It has been less than four months since my bearish post on J.C. Penney (JCP). Since then the $42 stock has fallen nearly 40 percent to $26 per share. It turns out Ron Johnson does not have magical pixie dust to sprinkle on his 1,100 stores. As the retailer slashes prices on old merchandise, initiates an everyday low pricing strategy, and begins shifting towards its “stores-within-a-store” concept, sales and profits are plummeting. Same store sales fell 19% last quarter, a figure almost unheard-of in the retail sector. The stock is below its level on the day Ron Johnson was hired.

So what now? Well, the stock is no longer clearly overvalued, as it was four months ago. In the mid-twenties, it now has material upside if Johnson’s plan bears fruit. It will still take a long time, so investors need not rush in if they still believe in the new management team. That said, it is probably time to start formulating a game plan if you want to get in. The first quarter results were really the first in what may be a series of bombs as the company right-sizes its inventory and pushes forward with its revamp. The year-over-year comparisons early next year will be very favorable for the company. And who knows, maybe Johnson can drum up some excitement over the holiday season. He does have another six months or so to make a strong push there.

For investors who want to get in on the Ron Johnson JCP experiment, it seems reasonable to scale in slowly with an understanding that Q4 2012 and Q1 2013 may be when we start to see the sales and profit figures turn around. Between now and then we really don’t know how bad it will get. The stock could certainly drop to the low 20’s or even high teens depending on how 2012 progresses and if the red ink continues short term.

Still, as Bill Ackman of Pershing Square Capital Management pointed out shortly after JCP’s recent earnings miss, there is still a lot of potential here and we are really only in the first inning of the company’s plan. Specifically, he pointed to sales of $600 per square foot in JCP’s in-store Sephora boutiques. If Johnson can get exclusive merchandise in JCP and mimic the Sephora “store-within-a-store” concept, there is certainly upside here. Given that the stock was worth about this much before he was even hired, he would really have to screw up the entire brand and alienate his customers in order to destroy the stock permanently. As a result, JCP’s turnaround remains a very interesting story to watch.

Full Disclosure: No position in JCP at the time of writing, but positions may change at any time

Is Priceline’s Stock Valuation Out of Whack with Reality?

Rob Cox of Reuters Breakingviews was on CNBC this morning sharing his view that the stock of online travel company Priceline.com (PCLN) appears to be dramatically overvalued with a $30 billion equity valuation (even after today’s drop, it’s actually more like $35 billion). Rob concluded that Priceline probably should not be worth more than all of the airlines combined, plus a few hotel companies. While such a valuation may seem excessive to many, not just Rob, it fails to consider the most important thing that dictates company valuations; cash flow. In this area, Priceline is crushing airlines and hotel companies.

As an avid Priceline user, and someone who has made a lot of money on the stock in the past (it is no longer cheap enough for me to own), I think it is important to understand why Priceline is trading at a $35 billion valuation, and why investors are willing to pay such a price. While I do not think the stock is undervalued at current prices, I do not believe it is dramatically overvalued either, given the immense profitability of the company’s business model.

At first glance, Priceline’s $35 billion valuation, at a rather rich eight times trailing revenue, may seem excessive. However, the company is expected to grow revenue by nearly 30% this year, and earnings by 35%, giving the shares a P/E ratio of just 23 on 2012 profit projections. Relative to its growth rate, this valuation is not out of line.

The really impressive aspect of Priceline’s business is its margins. Priceline booked a 32% operating margin last year, versus just 4% for Southwest, probably the best-run domestic airline. With margins that are running 700% higher than the most efficient air carrier, perhaps it is easier to see how Priceline could be worth more than the entire airline industry.

Going one step further, I believe investors really love Priceline’s business because of the free cash flow it generates. Because Priceline operates a very scalable web site, very little in the way of capital expenditures are required to support more reservations and bids being placed by customers. Over the last three years, in fact, free cash flow at Priceline has grown from $500 million (2009) to $1.3 billion (2011). At 27 times free cash flow, Priceline stock is not cheap, but given its 35% earnings growth rate, it is not the overvalued bubble-type tech stock some might believe.

Full Disclosure: No positions in any of the companies mentioned, but positions may change at any time

The Sears Holdings Dismantling Begins… Years Too Late

It is February 23rd and shares of Sears Holdings (SHLD) have already risen 100% this year, after a more than 20% jump today to nearly $64 per share. Such gains seem irrational, given how poorly the retailer’s business has been, but keep in mind that the stock opened 2011 about 10 points above where it currently trades, so you had to be quite nimble (and daring) to capitalize on the recent surge.

Today’s stock strength is due to the fact that the company seems finally ready to start splitting itself up, as it believes (probably correctly) that the sum of its parts are worth more than the whole. Sears will spin off its Hometown, Outlet, and Hardware stores (about 1,250 of the company’s 4,000 stores) via a rights offering to existing shareholders. This comes on the heals of the recently completed spin off of the Orchard Supply Hardware (OSH) division. Sears Holdings expects to reap $400-$500 million from the separation, which equates to about 7 times annual EBITDA of ~$75 million.

Splitting up the company is the right call, and should have been done many years ago when the retailer was far more profitable. Annual cash flow at SHLD peaked in 2006 above $3 billion and has collapsed, coming in at just $277 million in 2011. Interestingly, however, Sears has been spinning out its small and less desirable assets. Orchard Supply, now public, is a small cap stock, as will be the specialty store business later this year. The company’s crown jewels (Kenmore, Craftsman, Die Hard, Lands End) remain deeply hidden within the parent company, making it very hard for investors to figure out their intrinsic value.

In fact, Sears also announced today the sale of 11 stores for $270 million to a large mall operator (General Growth Properties). Selling just 11 of its full line Sears stores will bring in more than half as much cash as a complete spin off of their 1,250 unit specialty store business. It is a nice way of padding their balance sheet and alleviating concerns about a cash crunch and a possible bankruptcy (those rumors are completely baseless by the way), but it doesn’t really create all that much in the way of shareholder value.

The biggest problem Sears Holdings faces is that even with its crown jewels, the operating businesses are barely profitable (cash flow margins came in at less than 1% in 2011). Many of their stores are worth more to a strategic buyer like GGP ($24 million each) than they are on the public market inside SHLD. Before today’s stock jump the company had $5.5 billion of store inventory that was fully paid for. The equity value of the entire company was also $5.5 billion. Similarly, Lands End and Kenmore would both likely garner multi-billion dollar valuations as standalone companies, but aren’t inside SHLD. By spinning out the specialty business (32% of the store base and 27% of cash flow) for just $450 million, you can easily see that SHLD is worth more busted up than it is as a retailer.

Which brings us to the problem for investors with the stock now well north of $60 per share (a $9 billion enterprise value). As long as SHLD management is content doing smaller breakup transactions to pad the balance sheet, and not large ones to truly show Wall Street how much their brands and real estate could be worth on a standalone basis, it is hard to see how a pure play retailer with less than $300 million in annual EBITDA is worth $9 billion as an operating conglomerate. Management would argue that they will be able to improve profit margins by retooling the company’s retail strategy, but we are talking about Sears and Kmart here. That argument holds no water. Those stores are dying a slow death plain and simple.

The bottom line from my perspective is that with bankruptcy talk in the media and this stock at $30 (as was the case a few months ago) it is a very cheap stock. With only small moves being consummated to create value and those cash crunch rumors off the table, $64 per share is a tough sell for would-be buyers of the stock. The right number is probably somewhere in between as long as SHLD continues to focus most of its attention on improving the retail operations. If and when the focus becomes monetizing their various brands and real estate assets no matter what path that leads them on, then investors can start to get serious about the stock as an investment.

Full Disclosure: No position in Sears Holdings at the time of writing, but positions may change at any time

JCPenney: Great New Ads, Overbought Stock

Shares of department store retailer JCPenney (JCP) have been on a tear this month (up 20% year-to-date, from $35 to $42) after the company unveiled a new advertising campaign (love it!) and shared with investors the details of its new retail strategy. I recently wrote that the stock made sense, at the right price, given the potential for Ron Johnson to start working his magic. That price never really materialized and now that the stock has jumped into the 40’s, it looks too expensive.

How can we value the shares given that business has not been great and the new CEO could really turn things around? It is not an easy task, but since Johnson turned Target into a hip retailer more than a decade ago, that seems like a good place to start. Let’s assume Johnson can get JCP’s margins all the way up to those of Target. That is a hefty assumption (and one that even if accomplished will likely take years, not months or quarters) but using optimistic projections can really help investors figure out what the upside could be. In 2010 Target earned 11% cash flow margins, versus just 7% at JCP, so Johnson clearly has some room to boost JCP’s profitability. However, that upside is largely negated by an expensive stock price after a 20% gain so far in 2012. JCP shares trade at 8 times trailing cash flow, versus just 7 times for Target.

Target currently fetches an enterprise value-to-revenue ratio of 0.75 times. If we assume JCP can match TGT’s profit margins (again, a very optimistic assumption) they too would fetch the same price. We can use EV-to-sales here because with the same level of profitability, sales and earnings multiples are interchangeable. Giving JCP a 0.75 EV-to-sales multiple puts the equity value at about $10.75 billion (excluding $2 billion in net debt), versus $9 billion today. The stock price at that level would be right around $50 per share.

So if Ron Johnson can turn JCP into a profit machine like Target, and we assume the stocks trade at similar valuations to reflect their strong businesses, JCP stock could rise another 20% or so, from $42 to $50 per share. It could be worse, of course, but with those numbers it is hardly an overwhelming attractive investment at current prices. That gain would be several years away, and assume Ron Johnson can live up to the hype he earned at Target and Apple, even though JCP is clearly in a more challenging competitive position.

As a result, I am steering clear of the soaring stock even though the TV commercials are great and the odds are good that Johnson will greatly improve the store experience over time.

Full Disclosure: No position in JCP at the time of writing, but positions may change at any time

Ron Johnson’s First Target at J.C. Penney: Martha Stewart

News reports are coming out this morning that J.C. Penney (JCP) is set to buy a 17% stake in Martha Stewart Living Omnimedia (MSO) for $38.5 million. Not only is this Ron Johnson’s first big step as CEO, it also sheds light on his strategy with the retailer now that he has moved on from Apple to a different kind of retailing operation. There is no doubt that Johnson will be focusing on brands and how to get the best assortment of products in his stores to attract more traffic. He has always said that the reason Apple stores are successful is less about the design of the store and more about the actual products they offer.

Martha Stewart is the perfect candidate for JCP given her mass following. And the fact that her company doesn’t make a profit makes for a relatively cheap investment (less than $40 million is peanuts for a multi-billion dollar retailer). A stronger relationship with Martha Stewart should yield huge returns on this small monetary investment.

Ron Johnson’s track record building out the Apple store concept makes JCP an interesting stock to watch. Given the current price in the low 30’s and the fact that a revamp of the company’s stores is likely to take a lot of time as well as a lot of money, I would not expect financial results to accelerate quickly. This is likely more of a 2013-2014 story from an earnings and sales perspective (not 2012).

In fact, hints of increased corporate expenses as Johnson implements his plan could pressure earnings short term and cause a negative reaction on the company’s shares. At that point, investors might want to take a strong look at the stock if the price is right. In the mid to high 20’s I would be intrigued (the stock closed yesterday at around $33).

Full Disclosure: No position in JCP at the time of writing, but positions may change at any time.