Almost as soon as Pershing Square's Bill Ackman abandoned his position in J.C. Penney (NYSE: JCP ) , two other big players jumped in--Glenview Capital Management and J. Kyle Bass' Hayman Capital Management.
They joined George Soros' Soros Fund Management and Perry Capital as the biggest shareholders in the company. Among them the four groups hold a little over 70 million shares, almost one third of the 220 million shares outstanding.
Are they crazy? Or do they know something we don't?
What They Know
What these four know is a bargain, in conventional retail stock terms. At its current market cap of just $3 billion, J.C. Penney is selling for less than 33 cents for each dollar of sales, even at its current sales run rates. These rates are down 35% from 2011, when former CEO Ron Johnson of Apple fame began his ill-fated reign under Ackman's sponsorship.
While the company hasn't made money in over a year, the quarter ending in August, with some time post-Johnson on the books, showed a little bit of progress, with losses down nearly one third from the nearly $750 million lost during the crucial Christmas season of last year. Sales were also up, slightly, from the quarter before, an indication that some Penney shoppers may be coming back.
The balance sheet remains in pretty bad, showing nearly 50 cents in debt for each dollar of assets. But returning CEO Mike Ullman has performed some miracles on the cash flow front, using $2.7 billion in new debt financing to make the company cash flow positive again.
Ullman also brought in an experienced marketer Debra Berman from Kraft, to bring back the brand's old message. Penney remains a fixture in many American malls, and just two years ago had sales of $17 billion. The company is pushing discounts again to bring people into those stores, and Berman's main task will be to bring back sales in home furnishings, once a mainstay of the company but now a disaster.
In other words, if Penney's just gets back to where it was when Ullman left it, the new investors will have some major gains.
Compared with Penney, other retail stocks are fully priced. Kohl's (NYSE: KSS ) may be among the best competitors, as it sells much of the same merchandise. The company has a market cap of about $11.7 billion on about $19 billion in sales, meaning you're paying $1 for each 60 cents of revenue.
Kohl's uses out-parcel locations for its stores, not the malls Penney uses. It consistently brings 10 cents on each sale down to the bottom line, and its balance sheet shows about 30 cents in debt for each $1 in assets. Kohl's sports a Price/Earnings multiple of 12.4, close to the market averages – Penney's is operating at a loss – and offers investors a yield of 2.65%. Trouble is, the stock has gone sideways for over a year, up only 3%. It's a nice, safe investment, but won't make you a lot of money.
Macy's (NYSE: M ) , which, like Penney, mainly operates in malls, is in slightly better shape. The company has equity of $17 billion on $27 billion in sales, in line with Kohl's, even though it brings less than 5 cents of sales down to the net income line. The debt-equity ratio is slightly higher than Kohl's as well, about 33%, but it throws off slightly more cash than Kohl's, with both companies at near $1.5 billion a year. The P/E is a little higher than Kohl's, slightly over 13.
Macy's is what Penney wants to be: a marginally profitable mainline retailer that can anchor shopping malls rather than being a drag on them. One of the biggest risks for Macy's shareholders, in fact, may be a Penney's collapse, as it would decrease customer count at malls it counts on for its own survival.
A Foolish Bottom Line
Big investors are not betting they can turn Penney's into Wal-Mart, which has 50 cents in equity for each dollar of sales, nor Costco, the current darling of the space, which shares that ratio. They think that if Ullman can make Penney's what it was before Ron Johnson and Bill Ackman darkened its doors, they will make some huge profits.
If Penney's had $17 billion in sales, as it did in 2011, and had a conventional retailing valuation of 50 cents in equity for each dollar in sales, you're looking at a stock that's worth $8.5 billion, against the current valuation of $3 billion. That's just if it gets back to where it once was, which should be possible with the old team back in place.
All this is speculative, of course. J.C. Penney may be a great place to throw a little mad money right now, speculative capital you can afford to lose, risk capital. Investors who are afraid of losing money are better off looking elsewhere, but if you're of a speculative bent, like George Soros, Kyle Bass and their ilk, a little play on this stock may turn out OK.