We’re adding JCP to our real-time alerts marking the first out of 15 trades where we are not bearish. As a reiteration as to how our process works, our analytical team (McGough, in this instance) will do the long term fundamental analysis, and will put a stake in the ground on a small number of big ideas -- one of which is JCP. Then at the PM level (Keith), we’ll simply manage risk around the position, which has been 87% on-target thus far on JCP. Risk management levels are in the chart below, though an important point is that if TREND breakout happens here, there's no resistance to TAIL risk line of 24.76.
We turned fundamentally positive on JCP last month when near-term sentiment became too bearish at a time when the delta in top line is likely to get better. We think that the improving sales trajectory in 2013 and incremental improvement in store layout and dot.com business will drive the stock higher this year – even if JCP needs to buy the better top line. That might not be the best ROIC decision, but we think that this stock will trade on revenue, not ROIC.
To be clear, this is a rental, and not a long term buy. The challenges that this company faces in completing the transition are sizable. But people are getting bent out of shape on issues like shop-in-shop installation delays, and scale back in RFID rollout, which has very little impact on the key factor that would cause another big leg down – and that’s liquidity.
We won’t argue that liquidity is a non-event. It certainly is. But the numbers and scenario analysis tell us that we won’t need to answer that question for 2-3 years at least. Look at Sears. It’s still dogging along 8-years after the K-Mart merger. Granted, it has assets like Craftsman, Land’s End, Die Hard and Kenmore – while JCP is limited to about $10 per share in real estate value. But this is real estate that it can continue to monetize piece by piece to fund its transformation if need be.
Also keep in mind that while JCP uses all 3rd party brands (aside from a dwindling portfolio of value-less private label) and cannot sell anything like SHLD could, the reality is that there are hundreds of brands that are at risk of going away on their own – even without JCP dynamics. Even plenty of good brands face meaningful risk. They’ll flex wherever and whenever they can to get additional distribution to stay alive. They need JC Penney -- at least for a short time until they find alternative solutions.
The punchline is that we think that liquidity will be an ongoing concern, but it won’t be proved a valid concern anytime soon. What will matter are store-level trends and execution of JCP’s transformation. Whether the company SHOULD transform or not is irrelevant. The fact is that it is moving forward with the strategy, and after a brutally painful 2012, Johnson has more levers to pull in 2013 to instill hope in the investment community. That might be all we need with 30% of the float short.