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:
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:
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.
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.
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.
Fool contributor Adam Levine-Weinberg is short shares of Netflix. The Motley Fool recommends Netflix. The Motley Fool owns shares of Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.