J.C. Penney Stock Could Be Headed for Single Digits After CEO Shakeup

For more than a year, I have been following the transformation fiasco at J.C. Penney (NYSE: JCP  ) . On Feb. 5, 2012 -- as the stock was nearing its peak above $40 -- I suggested that the company was "the Netflix of 2012", referring to Netflix's 75% fall from peak to trough during 2011. Sure enough, J.C. Penney stock has fallen nearly 70% since I suggested back then that investors should sell or short the company:

JCP Chart

J.C. Penney Stock Chart (Feb. 1, 2012-present), data by YCharts.

J.C. Penney's dreadful performance can be attributed primarily to the ambitious but poorly tested transformation plan implemented by CEO Ron Johnson shortly after his arrival at the company. Johnson's merchandise changes and attempts to dramatically scale back the use of coupons and sales alienated many previously loyal customers. On Monday afternoon, J.C. Penney's board confirmed the inevitable, firing Johnson after only 17 months on the job.

The new (old) boss
Unfortunately for shareholders, J.C. Penney stock dropped by more than 10% when the markets reopened on Tuesday. Apparently, Mr. Market wasn't inspired by the J.C. Penney board's choice of successor: Mike Ullman. Ullman was the CEO who was pushed out in 2011 to make room for Johnson. At the time of Johnson's hiring, shareholders were delighted to get rid of Ullman. In fact, J.C. Penney's largest shareholder, activist investor Bill Ackman, was instrumental in bringing Johnson on board. It is somewhat understandable that shareholders were happy to show Ullman the door; J.C. Penney stock delivered a total return of approximately negative 12% in the six-and-a-half years between when Ullman became CEO and when Johnson's hiring was announced:

JCP Total Return Price Chart

J.C. Penney Total Return (December 2004-June 2011) data by YCharts.

To some extent, Ullman was playing with a bad hand; his previous tenure included the Great Recession, which decimated nearly all retail stocks. That said, Kohl's was able to contain the damage from the recession, and Macy's has bounced back very strongly, posting four straight years of double-digit EPS increases. Meanwhile, J.C. Penney was already on the way back down when Ullman left, with same-store sales down 1.6% and gross margins down 160 basis points year-over-year in his last quarter at the helm, driving lower adjusted EPS.

J.C. Penney stockholders thus have good reason to doubt that Ullman has any good answers for the company's woes. The company's long-term underperformance vis-a-vis Macy's and Kohl's is largely the result of its stodgy image and aging customer base. As I wrote back in February, bringing back sales won't necessarily bring back profits (or customers) for J.C. Penney. In fact, there are some good reasons to believe that performance will continue to slide; when all is said and done, J.C. Penney stock could be sitting in the single digits.

Challenges ahead

It seems all but certain that first-quarter sales have been dreadful, and I expect J.C. Penney to lose even more money than it did last year, when it posted an adjusted loss of $0.25 per share. While the company's comparable-store sales decline of 18.9% in last year's first quarter shocked the market, revenue losses actually accelerated through the rest of 2012. J.C. Penney posted a 31.7% comparable-store sales decline in the fourth quarter. If that sales pace continued into the first quarter, J.C. Penney will post another double-digit revenue decline this quarter. Furthermore, J.C. Penney achieved a very respectable gross margin of 37.6% in last year's first quarter; the return of discounting could easily push that figure much lower.

Some J.C. Penney stock owners hoped that the return of sales and coupons, along with the launch of new mini-shops this spring -- particularly the much-hyped Joe Fresh shops -- would stabilize sales. The firing of Johnson two months into the quarter decisively refutes that notion. Most analysts believed that Johnson had the rest of the year to turn things around; the board's decision to pull the trigger this week strongly indicates that business has continued to deteriorate. This is further supported by the choice of the uninspiring Ullman as the next CEO: His best qualification is his deep knowledge of the company, which could make him a stabilizing force.

Liquidity will be another major challenge for J.C. Penney. Last month, I wrote that barring any asset sales during the first quarter, operating losses and heavy capex were likely to use up all of the company's $930 million year-end cash balance. Given the current trajectory, J.C. Penney will probably need to tap into its credit line this year to cover operating losses. The company will have trouble raising new capital given the low stock price and the market's disgust with J.C. Penney's debt, which is trading well below face value. This will leave executives with very little financial flexibility as they try to turn the business around.

Foolish conclusion
Like another long-suffering retail behemoth, Sears Holdings, J.C. Penney probably has enough attractive assets to stay out of bankruptcy for the foreseeable future. That doesn't mean that you should go anywhere near the stock, though. The company still has massive challenges ahead, such as continued sales weakness and growing liquidity issues. These problems could sink J.C. Penney stock into the single digits by the end of the year.

J.C. Penney's stock cratered under Ron Johnson's leadership, but could new CEO Mike Ullman present the opportunity investors have been waiting for? If you're wondering whether J.C. Penney is a buy today, you're invited to claim a copy of The Motley Fool's must-read report on the company. Learn everything you need to know about JCP's turnaround -- or lack thereof. Simply click here now for instant access.

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  • Report this Comment On April 11, 2013, at 4:08 PM, JCpenneywise wrote:

    In defense of Mike Ullman, I would like to point out a few things regarding his last year as CEO. When Bill Ackman started pressuring the company to make changes, Mike Ullman and JCPenney decided to put him on the BOD instead of publicly fighting with him. His thought was if he was on the BOD, changes could be instituted from within and with the guidance of other directors on the board.

    When Ron Johnson was named to the BOD in 2011, changes were already beginning to take shape. By the 3rd quarter and Ullman announced his "retirement", the business climate within JCPenney began to take a turn for the worse. Many top executives spent more time networking and looking for employment outside JCPenney than performing in their jobs. Chief Marketing officer announced his"retirement" before holiday of 2011. Not that that was the problem. The marketing and advertising strategy had been stagnant for years and the continuous year after year same marketing approach just didn't work. It needed a change but never changed. As a former store manager, I got very frustrated at the same promotions being run year after year with little to no change in results.

    Has Mike learned some things from this? I am sure he has and I think it was wise of the board to bring him back on an interim basis if only to calm things down and try and bring some sensibility to JCPenney. While I agreed with some of Ron Johnson's principles, his execution couldn't have been more sophomoric for someone of his background. He completely destroyed the customer engagement principles that Mike Ullman and his team instituted years before, which helped to drive business.

    I guess now we just have to wait and see if this once great company can be saved...

  • Report this Comment On April 11, 2013, at 4:55 PM, TMFGemHunter wrote:

    Thanks for the comment. I'd agree that Ullman got a raw deal back in 2011, but I think he was managing J.C. Penney's decline rather than sparking any kind of lasting turnaround. Even Kohl's has been hit hard by the squeezing of the middle class in recent years. J.C. Penney is in even worse competitive position because of its higher exposure to malls (and particularly mid-low quality malls).

  • Report this Comment On April 11, 2013, at 7:16 PM, TMFGemHunter wrote:

    Wall Street Journal just published an article stating that J.C. Penney is working with Blackstone to try to raise $1 billion. The problem (as I noted above) is that the stock has dropped so much that JCP would have to substantially dilute the share count to raise that kind of money. On the other hand, JCP bonds are already yielding nearly 10%, and throwing another $1 billion on top of that would probably drive yields even higher. The last thing JCP needs right now is another $100 million or more of annual interest expense.

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