J.C. Penney Company, Inc. (JCP), Macy’s, Inc. (M): Pulling Off The Miracle on Main Street

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It would be worthy of a holiday movie if J.C. Penney Company, Inc. (NYSE:JCPturned profitable by spring 2014. The company is challenged by its tremendous cash burn, the defection of 30% of its core customers to competitors, and a company-wide morale problem after ousted CEO Ron Johnson slashed the workforce by 20,000.

Getting back to the core customer
The company’s main focus is bringing back the core customer, especially during the holiday season.

In the company’s favor, Pershing Square Capital Management activist investor Bill Ackman left the Board and sold his stake, losing over $400 million. Few people have less in common with the average J.C. Penney Company, Inc. (NYSE:JCP) shopper than Ackman, who is under 55. His annual income also isn’t under $100,000 like 87% of J.C. Penney shoppers.

A longtime shopper explaining her dissatisfaction with Ackman’s pick, former CEO Ron Johnson, told Forbes, “He didn’t have a clue as to what low prices are, but when you make a seven-figure salary, you can’t connect with the middle-income family trying to make ends meet.” The shopper also mentioned that the company needed to bring back her beloved private brands St. John’s Bay and Cabin Creek. Interim CEO Mike Ullman did just that after his return as CEO in April, and he also reinstated the three-tier loyalty program and reissued J.C. Penney Company, Inc. (NYSE:JCP) credit cards.

In encouraging news, vendor Fifth & Pacific Companies Inc (NYSE:FNP) fielded analyst questions about J.C. Penney Company, Inc. (NYSE:JCP) on their conference call. Fifth & Pacific CEO William McComb said this:

J.C. Penney Company, Inc. (NYSE:JCP)“At Penney’s, here’s what I’ll tell you. It — the old recipe for success is back in place, maybe with a couple of improvements and some new flair. But generally speaking, they are very quickly returning to the core areas that were abandoned in the attempt in 2012 to remake the whole store. And I think this is good. What I’m seeing, I like. I’m seeing a commitment to getting back to a core customer.”

The bull arguments
Despite McComb’s insight, the stock trades near 52 week lows again. However, Buckingham wrote in a note that Ackman’s sale removes an overhang, giving it a Buy with a price target of $20.00 and will help to attract a permanent CEO. Other initiatives include the hiring of former Kraft Foods Group marketing executive Debra Berman as new senior vice president of marketing.

As for morale, at one point morale was so low that the company brought in a therapist to talk at a merchandising meeting. It did not go down well.. Surprisingly, glassdoor.com states that 58% of employees approve of Ullman and the company receives a 2.9 star rating out of 5.

Ullman has brought back the sales and the private brands to arguably more clean and attractive stores. In fact, Ullman wants to bring private label brands back up to 50% of merchandise.

The company’s second quarter earnings release showed its same store sales gradually improving, and its online sales in July were up 14%. Still, its same store sales were down over 11% in the quarter and its gross margin was below 30%, less than the historical margin of 37%. However, CFO Ken Hannah said on the call,” We see no reason why we can’t return to historical margins. But what’s weighing on the margins today is the disposition of merchandise the customer didn’t relate to and that should subside during the third quarter.” (source Seeking Alpha transcript).

As to cash burn, Hannah said they expect in excess of $1.5 billion in liquidity by year end. Analysts did ask if the company might have to resort to outside liquidity injections and Hannah responded no. UBS Investment Bank’s Michael Binetti thinks the company will run through $910 million by year end but predicted same store sales may be up 3-4% in the back half.

Miracle on 34th Street vs Miracle on Main Street
Finally, the customers’ defection to competitors issue is valid as rivals like Macy’s, Inc. (NYSE:M) attracted J.C. Penney Company, Inc. (NYSE:JCP)’s customers. Last fall, Macy’s was on its way to displace J.C. Penney as the number 3 shopping destination for the average shopper behind Wal-Mart and Target. A BIGInsight consumer survey extrapolated that as many as 1.3 million women have stopped shopping at J.C. Penney.

On their second quarter conference call,  Macy’s, Inc. (NYSE:M) CFO Karen Hoguet was asked about any impact from J.C. Penney Company, Inc. (NYSE:JCP)’s promotions and pointedly didn’t answer. One of the strengths for Macy’s quarter was women’s apparel, but they also saw softness in the budget conscious shopper, the core demographic for J.C. Penney. With J.C. Penney seeing strength in women’s apparel, price-sensitive customers just might be returning.

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