Until JC Penney CEO Ron Johnson Admits Reality, It’s Hard To Be Bullish

The entire premise of the JC Penney (JCP) turnaround effort, led by former Target and Apple executive Ron Johnson, has been to do away with sales and just give consumers everyday low prices, a la Wal-Mart (WMT) and Target (TGT). That all sounds well and good, unless you actually learn anything about the core JCP shopper, who comes to the store for bargains. Sure, a $50 shirt that sold everyday at 60% off really is not a $50 shirt. But if the consumer pays $20 for it, they feel like they got a great deal, even if the shirt’s quality is on par with a $20 comparable item at Wal-Mart or Target.

So it was not surprising to learn that as soon as JC Penney started to get rid of sales and instead just marked their products at the “real” price ($20 in the above example), consumers fled. Comparable same store sales in Q1 2012 dropped 19%, the first quarter the changes went into effect. Q2 comps dropped 23%, then -26% in Q3, and earlier this week JCP reported Q4 comps of -32% (which must be a record decline for any retailer in history that was not facing some sort of natural disaster or other event preventing people from making it to the store).

The first solution a CEO in this position should make is to bring back sales. If you are going to get $20 for a shirt either way, you may as well mark it such that someone buys it. And in yesterday’s conference call, JCP CEO Ron Johnson announced that the company will bring back sales once a week. Sounds great for JCP bulls, right? Well, not exactly. You see, on one hand he announced that he is bringing back sales (because the consumer is demanding them), but on the other he still seems to be insisting that consumers don’t need “fake” prices to understand the value proposition JCP is offering them. Consider the following quote from Johnson during Wednesday’s conference call:

“So we learned she prefers a sale. At times she loves a coupon and always, she needs a reference price. Whether there’s a manufacturer suggested price on a branded item, a comparison on a private label item or a sale, she needs to feel she added value to her family through the saving she got from being a savvy shopper. So we have brought back sales. We have brought back coupons for our rewards members, although we still call them gifts and we’ll offer sales each and every week as we move forward. But we will do it differently than we did in the past.”

Okay, fine. But then here was the very next thing out of his mouth:

“We don’t need to artificially mark up prices to create the illusion of savings. We can offer the industry’s best everyday prices and deliver even more exciting value through our promotions. Let me give you an example through our recent experience with jewelry at Valentine’s Day. Forever customers have asked the question, what is this piece of jewelry really worth? While we want to show the customers the value we offer, so we had nearly all of our jewelry appraised by IGI, the world’s largest gemological institute and provided our customers with a true appraisal of our jewelry for insurance purposes. We then price the jewelry below the appraised value. During Valentine’s Day we offer the customer an additional 20% savings and our rewards customers a onetime box of See’s Candy with every purchase over $75 and it worked.”

I nearly fell off my chair when I heard Johnson say this. The first paragraph is an admission of what we have learned over the last year at JCP; consumers will only buy their items when they get a marked down price, even if the original price on the tag is never what anyone ever actually pays. And then, in the very next breath, Johnson says “We don’t need to artificially mark up prices to create the illusion of savings.” Excuse me? You just said that you have learned that your customer needs a reference price (such as a tag with a MSRP), which is an artificial mark-up by definition (since nobody ever pays the full price), and at the same time that you do not have to create the illusion of savings. But that is exactly what the entire business model of constant deep-discounts and couponing requires!

So, yes, when other commentators call Johnson delusional, I can’t help but think they might be right. And he even takes it one step further. When he gives the jewelry example he states “We had nearly all of our jewelry appraised by IGI, the world’s largest gemological institute and provided our customers with a true appraisal of our jewelry for insurance purposes. We then price the jewelry below the appraised value.” He must think every consumer is an idiot. Anyone who has ever had a piece of jewelry appraised for insurance purposes knows that the appraised value is always higher than the price you actually paid. Johnson is married, so surely he bought an engagement ring and had it insured, so he knows this. And yet he wants us to think that getting JCP’s jewelry pieces appraised and the selling them at 20% off that price is not an “artificial price that creates the illusion of savings?” That is exactly what it is (which, by the way, is perfectly fine since it works in the store).

If you are an investor in JCP, 2012’s financial results quarter-by-quarter, combined with Johnson’s comments during the latest conference call, have to make you wonder what on earth is going on inside his head. He acts and talks like he is a marketing genius and smarter than everyone else but his customers are voting loud and clear by shopping elsewhere.

So what about the stock? It traded down 15% on this latest earnings report and is once again in the high teens. Management has lost credibility and has proven they do not have a handle on the business. Last year they publicly predicted that the second half of the year would show improvement after a first half comp store sales decline of 21%. This statement baffled me and I even wrote in my last JCP post that I thought the fourth quarter would be their worst of the year since the holiday season depends on discounting the most and that was exactly what they were abandoning . I postulated that sales could drop 30% in Q4 (read that article here: “An Inside Look at the New JC Penney“) and many JCP bulls thought that was far too pessimistic. It turns out that I was 2% too optimistic, as sales fell 32% during the holiday quarter.

Until JCP’s sales stabilize, I cannot any reason to invest in the stock. We simply do not know where the floor is and management has no clue either. In fact, considering that Q1 2012 comps were down 19% and Q4 2012 comps were down 32%, even if sales stabilize, you are still looking at further comp sales declines for the first 9 months of 2013 (dropping 13% in Q1, followed by a 9% drop in Q2, and a 6% drop in Q3, leading into flat sales in Q4). One could also try and project Q1 2013 sales by looking at the Q4 to Q1 sequential drop off from last year (-42%). Using that same sequential decline for 2013, Q1 sales would actually fall by 28%. I think -13% is closer to the right number, but only time will tell.

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