Even With Ron Johnson Out As CEO, No Closer To JC Penney Turnaround

Less than 18 months since he was hired to lead JC Penney (JCP), Ron Johnson has been replaced by his predecessor, Mike Ullman. Given that many industry people thought Johnson would be given all of 2013 to show signs that his store transformation plan was starting to bear fruit, the fact that he was fired in the first quarter tells me that customer traffic and same store sales have not improved this year. It also indicates that the highly publicized Joe Fresh launch was unimpressive as well. As a result, I do not think JC Penney will see sales stabilize this year, after falling 25% in 2012 (from over $17 billion to under $13 billion). First quarter same store sales are likely to fall by double-digits, making $12 billion in sales this year a reasonable estimate. As was the case last year, at that level of sales JCP will continue to lose money every quarter for a while.

Perhaps even worse for the stock, which I have been bearish on for a while now, the company is seeking to raise more money to continue refreshing their store base. Market chatter this week indicates that JC Penney is in discussions to raise anywhere from $500 million to $1.5 billion of new debt, and that comes after the company decided to tap $850 million of its $1.85 billion credit line in recent days. Add those borrowings to the $3 billion of long-term debt already on the books and it is entirely possible that by mid-year JCP will see its total debt nearly double to between $5 billion and $5.5 billion.

That amount of leverage is just as problematic for the company’s equity investors as is the deteriorating retail results. Troubled retailers often trade at an enterprise value equal to a fraction of annual sales. For instance, fellow money-loser Sears Holdings (SHLD) trades at 0.2 times revenue, compared with 0.8 times revenue for a well-run department store chain such as Macy’s (M). With annual sales trending towards $12 billion and more than $5 billion of debt, there is not much value left for the equity holders (at the current $15 share price, JCP’s equity value is still quite high, at more than $3 billion). The company’s near-term cash infusion will take a short-term liquidity event off the table, but if the retailer continues to pile up red ink, that cash will slowly bleed out, leaving the company with no way to reduce its debt load in coming quarters. That is how things could really begin to spiral out of control.

Even with its old CEO back at the helm, JC Penney is likely to struggle for a while. Bringing back coupons and heavy discounts could win back some of its old customers who left during Johnson’s tenure, but then you have the problem of all of this new merchandise. The assortments in the stores were meant to be higher end and attract a different customer. JCP’s old customer base does not know and/or care about Joe Fresh or Michael Graves. Not only that, but Johnson was able to sign on more fashionable brand names because he promised not to devalue their brands by offering huge discounts. No matter what the JCP strategy is going forward, it is hard to see how they can really reach profitability anytime soon.

If Ullman keeps the nicer product offerings with the high price points, the suppliers will be upset and the goods will continue to sit on the shelves. If they discount them heavily to move them out, JCP won’t make any money anyway. If they go back to the old merchandise and pricing strategy, many of the store’s previous customers may simply ignore them and keep shopping at the stores they now visit instead of JCP. I really don’t see any reason to be optimistic here and there have been no signs from the company that things are improving at all. Johnson’s abrupt firing only confirms that view.

As for the stock, there is no doubt that it is far cheaper now than it was at $42 when I first wrote a negative piece about it (JC Penney: Great New Ads, Overbought Stock). That said, it is hard to get a price target above the current $15 quote based on current fundamentals. Given how depressed the stock is and how many people are betting against it, there is upside potential on any business improvements whatsoever (and such a reaction would likely be sharp and swift), but until there are any silver linings in the company’s results, I would not feel comfortable making a bullish bet on that outcome. Remaining negative here is not without risks, as things could hardly get much worse, but if they don’t get any better I am fairly certain that traditional valuation metrics could easily dictate a stock price of $10 or less. Another bad quarter or two and even patient, long-term investors might decide to bail. As a result, bottom-fishers should tread carefully and watch for any signs of improvement in the actual financial results.

Full Disclosure: Long JCP put options (strike price of $20) at the time of writing, but positions may change at any time