Promised Land


Bullish on J.C. Penney, Despite Doubts

Andrew Feinberg

The CEO says most Penney stores will have 40 new brand-name shops inside them by late 2013.



Three of my four favorite stocks for 2012 are up an average of 23%. The other is in the witness-protection program, and its name can’t be divulged. Okay, okay, it’s J.C. Penney (symbol JCP), down 15% since I blessed it in my January 2012 column. I think I have some explaining to do.

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A few months ago, I sold all my Penney shares (though I held on to some options). Then I successfully shorted the stock, betting on its price to fall. Now I’ve bought shares again. In fact, Penney is one of my hedge fund’s ten biggest holdings.

Divergent Views

To say Penney is controversial is an understatement. Some bears think the company might go under. The most wild-eyed bull, well-known hedge-fund manager Bill Ackman, says the stock, $29 as of September 7, could near $300 a share over time (Ackman is on Penney’s board of directors).

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Dreams of such gains made me pounce prematurely. My biggest mistake was to believe that CEO Ron Johnson, who with Steve Jobs created Apple’s network of stores, could work his magic quickly. Retail turnarounds are notoriously difficult. And the successful ones, such as J. Crew, tend to take time.

Frankly, I got sucked in by Johnson’s brilliantly articulated vision of a glorious future, and I figured that some progress would be quickly evident. The opposite happened. Penney, which had always had an extravagant marketing budget centered on couponing, decided to stop using coupons and shift to everyday low prices (more or less). The idea bombed. It turned out that Penney shoppers liked coupons. Oops.

Once the coupon fiasco became apparent, I should have shorted the stock (I did eventually, but not soon enough). The coupon rebellion didn’t mean Penney’s plan was fatally flawed, but it did suggest that it would take a long time to change the behavior of Penney shoppers. The stock, which traded at $43 last February, went into freefall, eventually breaching $20.

The final insult came on August 10, when Penney reported awful earnings for the quarter that ended in July (a loss of 67 cents per share) and dreadful same-store sales (a key measure for retailers). But the stock rallied 5.9% that day after executives made upbeat comments in a post-earnings-release conference call.

Johnson told investors that traffic declines at Penney stores were abating. Levi’s, one of the first of 100 major brands to open a store within a store at Penney, saw sales climb 25% from the previous year. Johnson said most Penney stores will have 40 new brand-name shops inside them by the fall of 2013. Store-within-a-store operators will include Izod, Vanity Fair, Maidenform and Martha Stewart. Most important, Johnson said that Penney would resume growing in 2013.

There’s more. Penney executives announced that annual cost savings of more than $900 million are ahead of schedule, that the company will have more than $1 billion in cash at year-end and that it had booked one million free haircuts for the back-to-school season (one of the new kinds of promotions the company is using to lure customers).

Investors drove the stock higher, even as Wall Street frowned. One analyst worried that Penney could have a lousy Christmas season. So what? Penney has more than enough cash to survive a bad Christmas. Moreover, extraordinary value is buried within the company. Penney owns 49% of its real estate and leases the rest at an average of $4 per square foot—90% less than many mall tenants pay. Comparisons with Sears are obvious: Like Sears, it has great real estate. But unlike Sears, Penney has a credible retail strategy that should lead to earnings growth.

Could Penney stock fall 30% from here? Sure. But the potential reward looks much greater than the risk. Buy the shares and don’t look at the price until the 2014 winter holiday season. If you’re patient, I think it will be a merry one.

Columnist Andrew Feinberg manages a New York City–based hedge fund called CJA Partners.


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