• It's Coming...

    MARKET EDGES

    Identify global risks and opportunities with essential macro intel using Hedgeye’s Market Edges.

JC Penney is incentivizing management to drive short term earnings over long-term value. I don’t like it, even though Wall Street likely will. I can’t stop that freight train, but I can hop on board the Kohl’s express, which is a safer trip.

We’re all about Accountability and Transparency at Research Edge, and we think that one of the good guys in that regard is Michelle Leder and her team at footnoted.org. Her catch on the JC Penney 8-K earlier this month is classic.

“… this 8K that has some of the most self-serving language we’ve come across recently. Penney’s board has decided to give Chairman and CEO Myron Ullman III a supplemental performance grant ‘to provide an incentive for performance during the current economic environment and to recognize Mr. Ullman’s willingness to continue his service to the Company.’ A quick skim of the agreement doesn’t seem all that offensive, though at $25 million, it’s quite an incentive to something that really should be considered doing your job.”

We couldn’t have said it better, Michelle.

From my perspective, JCP needs all the incentives it can get. Yes, I’m about to pepper you with another noisy SIGMA quadrant chart. But check out how JC Penney is performing versus arch-rival Kohl’s. Rather astounding, I think. JCP is on its 7th consecutive of inventory growth outpacing sales growth, and its 5th quarter of down margins. The margin trajectory is zig-zagging all over the place, as both SG&A and Gross Margins are managed reactively.

On the other side we have Kohl’s. Its SIGMA trajectory (the yellow line that goes from 1Q07-3Q08) is a smooth arc that shows how management proactively clears its balance sheet in an effective manner while inventories build. Yes, margins are down today, but so are inventories relative to top line trends.
I would not bet against JCP at sub 3x EBITDA – even though I could argue that margins should take a 200bp hit from here (ie, nearly cut in half – again). The reality is that management is being incentivized to make the near-term call and pull levers that shouldn’t be pulled. That probably makes Wall Street happy – except for those who pushed short interest to all-time highs (10%).

Even at a 2x EBITDA point premium and less bullish short interest ratio (5% of float, down from 8.5%), I’ll take KSS any day over JCP as an investment. The fact that SG&A and capex compares get very easy 1 quarter out offers a nice cushion as well.

Keith and I will be revisiting these two more frequently as it relates to meshing my fundamental analysis with his ‘Trend vs Trade’ models.
The first chart (JCP) is just plain ‘ol ugly. It tells a story of a very defensive management team. In this environment, reactionary is evil. KSS is polar opposite. Quality matters…
Short interest definitely looking more bullish for JCP.