Examining J.C. Penney's Bad Day

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Last Thursday wasn't such a great day to own shares of J.C. Penney Company (NYSE: JCP  ) . On top of falling 8.39% during trading hours, shares of the struggling retailer fell another 3% after the market closed. Though even one piece of bad news can cause a company's share price to crater, J.C. Penney's fall was principally driven by four tidbits of bad news.

Is J.C. Penney losing support from the big players?
As shares in J.C. Penney have fallen this year, big investors like George Soros and David Tepper began making their way into the stock. One of the biggest players to do so was Kyle Bass whose hedge fund, Hayman Capital, owned as much as 5.2% of the company's shares in September.

However, by October his firm's stake in J.C. Penney had decreased to 1.87% of common shares outstanding. On Thursday, Kyle Bass announced on Bloomberg TV that he had sold off his firm's entire stake in J.C. Penney and explained that he was "not investing in a turnaround" of the company. This news prompted the sell-off as investors were already skittish about J.C. Penney due to share price volatility and deteriorating earnings results.

It should be noted that this news flies in the face of improved operating results. After seeing a continual decline in comparable-store sales, J.C. Penney stated that its October comps rose by 0.9% as a return to its previous pricing strategy has started to take hold. This news, however, has since been overshadowed by the company's November results which showed comparable-store sales rising by 10.1%, but at the possible price of widened net losses.

Another reason to dislike bankers
Irrespective of your personal views on the banking industry, you cannot deny that a lot of vitriol is directed toward bankers. Well, Thursday gave shareholders and management alike a new reason to dislike them; unflattering views of J.C. Penney's turnaround efforts.

In a note on Thursday, Wells Fargo & Company (NYSE: WFC  ) , a $277.8 billion bank, said that the retailer's November sales are "much less impressive" than they appear. According to Wells Fargo, the significant uptick in sales was attributable to a prolonged promotional event initiated by J.C. Penney that was designed to unload inventory and bring in sales.

Though this may come across as a good thing, Wells Fargo is concerned that investors might think the turnaround will be a rapid one while the likelihood is that the company's promotions will eat away at margins and result in a large loss for the fourth quarter. If these assertions weren't scathing enough, Wells Fargo also believes that J.C. Penney may be in a hole that is too big to get out of. Essentially, analysts at Wells Fargo are of the opinion that even with substantial sales growth, J.C. Penney's lack of profitability might ultimately be its undoing.

Here come the Men in Black!
To make matters worse for J.C. Penney, it released its quarterly report for the period ending November 2 on Thursday, which included a little Easter egg inside. On page 39 of the report, management provided a one-paragraph announcement stating that J.C. Penney is currently being investigated by the Securities and Exchange Commission, or SEC.

In the statement, the company revealed that the SEC requested information concerning its liquidity, cash position, and debt and equity financing on October 7. On top of this, the SEC would like to review all relevant data pertaining to the company's underwritten public offering of common stock that was announced on September 26.

In actuality, there are a number of explanations for this investigation. The one that investors likely fear the most is the possibility that regulators believe management misled investors leading up to the announcement of the stock sale. Immediately prior to relaying the news of a secondary offering to the public, CEO Mike Ullman stated publicly that the company had enough liquidity for the year and it was not in financial straits. This speedy flip-flop could have enticed regulators to start an investigation to find out whether any deceptive and illegal acts took place that would have robbed shareholders of value.

Everyone's a critic!
Just above the company's paragraph regarding its SEC investigation, there is another paragraph that talks about a lawsuit filed in October that alleges false and misleading conduct by the Board of Directors and other executives (both former and current). According to the paragraph, certain parties involved in the company breached their fiduciary responsibilities to shareholders and members of the class action lawsuit should be entitled to compensatory damages and other rewards.

Foolish takeaway
As we can see, J.C. Penney was hit hard today by a flood of bad news. At least one major shareholder has liquidated his stake in the company, while Well Fargo believes the news about its turnaround is overstated. Furthermore, the company is in the middle of a lawsuit and an investigation by the federal government, either one of which has the potential to cost it dearly.

Moving forward, it's hard to know what to do. I am not a fan of making buy or sell decisions based on lawsuits, reports, or major stake reductions by hedge funds. Rather, I believe that it is far more important for the Foolish investor to focus on the fundamentals of the company. Right now, these aren't particularly good, but some degree of improvement can be observed. This might mean that confident investors should see the hit J.C. Penney took as a buying opportunity instead of a sign of more bad times to come.

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9/23/2016 4:00 PM
JCP $9.78 Up +0.02 +0.20%
J.C. Penney CAPS Rating: *