JCP update

JCP released its earnings for Q3 2012 and they are really bad.  Comparable store sales have continued their dramatic decline:

Q1 2012:  -18.9%
Q2 2012: -21.7%
Q3 2012: -26.1%

This bodes well for the short thesis.  I did not expect sales to drop so much as I didn’t think that somebody could screw up the company so badly.  Apparently it is possible.  I’m not exactly sure why sales have been down so much… here are some possible explanations:

  1. Staffing is being cut down to the bone.  A few shoppers on JCP’s Facebook page have reported that it is difficult to find sales associates for help.
  2. Reduced advertising spending.
  3. Some JCP shoppers are unhappy that they cannot buy JCP private label items that have been discontinued (e.g. St. John’s Bay).  Their private label brands have their fans apparently.
  4. The new pricing model makes JCP’s clearance items look like a great deal relative to everyday pricing items.  JCP has seen a shift in the mix towards clearance items as indicated in the Q3 earnings presentation.  The old promotional model did not have this problem of clearance items cannibalizing non-clearance items.

I am guessing that JCP management continues to roll out changes in all JCP stores without testing their ideas beforehand.  The evidence to date suggests that the CEO has been running the company into the ground.  Allen Questrom, the former CEO of JCP with an impressive track record in retail turnarounds, has expressed disbelief in what Ron Johnson is doing.  I don’t mean to be extreme but the numbers and a credible expert in the field (Questrom) are saying that Ron Johnson is doing an abysmal job as CEO.

Going forward, I expect JCP’s business will continue deteriorate as long as Ron Johnson is CEO.  My plan is to cover my JCP short when the market cap reaches book value… I have no idea if it would be covering at too low or too high a price.  I anticipate that current management will eventually send the company into bankruptcy (the negative free cash flow and debt are dangerous) though I expect the CEO to be fired before that happens.  So I am not going to count on bankruptcy.  As well, JCP has valuable real estate assets that are carried on its books below market value.  Covering the short position at book value may be too greedy as JCP’s intrinsic value may be greater than book value.  It depends on how you value the real estate and how you penalize management.  I believe that JCP should trade at a sizable discount due to terrible management.

Accounting and operational tidbits at JCP

JCP capitalizes its software costs for in-house development.  Overly aggressive capitalization of software expenses could potentially be used to inflate/deflate GAAP earnings.  This may be difficult to spot as JCP has legitimate reasons to have higher than normal levels of capitalized software next year.  In the coming year, JCP may have IT spending above historical levels as it transitions to Oracle software, implements RFID and self check-out.  In the past, JCP has had increases in capitalized software costs.  2011 saw $120M, 2010 saw $100M, and 2009 saw $72M.

In terms of the big picture, I do not believe that the capitalization of software expenses is that important to valuing JCP.  Assuming that the capitalization of expenses is reasonable, JCP is still losing money if you look at GAAP profits, free cash flow (profits + D&A – capex), or cash from operating activities minus capex.

*Disclosure:  Short JCP.

One thought on “JCP update

  1. they certainly have their issues but no way this thing goes bk, cost cutting ahead of schedule and they have >$400m of liquid assets (REITs, etc) and even without working capital benefit they’d do $800m in cfo and just taking back of the envelope look at real estate it’s not hard to come to $8-9b in value just for that vs. $7b in ev. I’m not in the stock but there is zero chance this goes bk anytime soon and depending on how you look at it the stock could already be trading at book value or below. I’d say if comps have no bottom and they continue this death spiral downside target of $10ish could be expected but if they make this work we could see $50+ per share on the equity. Was an interesting short at $40 but here looks better on the long side with a gun to my head. But either way, no way they go bk and some of the debt yielding 8%+ looks interesting imo.

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