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JCP: Why Firing Johnson Is The Fastest Path To Ch11

Takeaway: Contrary to what others are recommending, we think that firing RJ is the fastest way to realizing the liquidity crunch bear case.

Conclusion: Contrary to what others are recommending today, we think that firing Ron Johnson is just about the stupidest thing that the JCP Board could do right now. If they did fire him, we think that it would be the quickest path to bankruptcy for JCP. Sentiment seems to us that the stock would go up on that news. But if we saw him ousted we’d likely short this name with impunity -- even with the sell-side capitulating at a price of $14/15. We think losing Johnson would pose significant vendor/brand risk, and would back JCP into a corner to liquidate its real estate at a discount.

 

A new CEO would be faced with a binary decision tree. Either A) Return to being the lowest-quality department store in America, or B) carry out Johnson’s shop-in-shop plan better than RJ could on his own. Johnson clearly blew himself up in 2012, but we don’t put blind faith in the ability for anyone to come in and implement this plan any better. Keep in mind that 75% of the problems JCP has had have little to do with changing up the shop format and upgrading the merchandise assortment – it was largely due to RJ getting the pricing/marketing/value proposition wrong on the existing merchandise. Letting RJ run with the current plan might carry more risk as 2013 unfolds – but doing it without him is riskier, with potentially more significant financial pain.

 
1) First off, once a cucumber becomes a pickle, you can’t reverse the process. It already has architected its square footage to new shops, chosen new partner brands, and gotten rid of hundreds of vendors to make room for what is coming down the pike. That cannot be undone, which leads us to the conclusion that a new leader would need to move forward with the current plan – or something pretty darn close to it. Unfortunately, JCP does not have the liquidity for a new CEO to shake the Etch-a-Sketch clean, start over, and create a new plan. The lack of capital deprives JCP of the oxygen needed to go down a new path.
 
2) Ron Johnson has spent easily a third of his time ensuring that the right brands/vendors are chosen, and then collectively working with the brands and his merchants to make sure that the right product is in the right place inside the store. Whether you like RJ or not, the reality is that the vendors still like him – a lot. They buy into the long term vision (even if no one on Wall Street does). We’re relatively certain that at least a few large vendors would balk at rolling out product inside JCP if leadership and strategy changed dramatically.  
 
3) If that were the case, JCP would be left half-pregnant.  It wouldn’t be able to fill the shelves quickly with legacy product (i.e. become the old, poor quality JC Penney), and the product that should ultimately drive traffic under the new plan is at risk of never becoming a reality. Then we can build to an algorithm where comps are down another 20-30%, and not only is JCP forced to use its full revolver, but to liquidate its real estate, which we estimate to be worth about $1.8bn-$2.1bn (see our note from last night “JCP: Duration Matters More Than Ever’) to fund operating losses.
 
4) Allen Questrom, the Godfather of retail (we mean that in a complimentary way), was on CNBC today talking about why RJ should be fired immediately. He said that the Board needs to admit its mistake and move on. At face value this carries a lot of weight given that Questrom is the only person to successfully turn around JC Penney. But let’s be real. When Johnson went down the path of ‘reinventing’ JCP, Questrom did not make the cut of people he leaned on to consult about a solution. Questrom likely viewed that as a snub, and also probably has little patience for anyone that is seemingly destroying something that he worked so hard to fix. Not really a shocker that Questrom is on the short list of people recommending that he’s ousted due to 2012’s failures. Also keep in mind that he’s on the short list of people that would be considered for the top job (though we have no reason to think that he’d want it).

 


FAREWELL "CHAVISMO"?

Takeaway: Hugo Chavez’s death does not necessarily pave the way for an end to hyper-socialist economic policies in Venezuela.

SUMMARY CONCLUSIONS:

 

  • While the death Hugo Chavez – who had nationalized over 1,000 companies during his presidency – represents an opportunity for Venezuela to become less socialist on the margin, it should be stated that two out of the three highest-probability replacement candidates (Nicolas Maduro and Diosdado Cabello) do not represent a material departure from Chavez’s socialist agenda.
  • To the extent Cabello doesn’t fall in-line with Chavez’s pre-death wish that Maduro succeed him, you could see an intra-party (United Socialist Party or “PSUV”) struggle for power that could split the Chavismo vote and ultimately result in essentially handing Capriles a victory due to his [likely] garnering of the lion’s share of the opposition vote.
  • On the margin, that would be particularly positive for Venezuela’s structural economic growth outlook and its capital markets (less socialism and Big Gov’t Intervention).
  • That said, however, assuming this scenario is not without a great deal of risk; the data supports a continuation of the Chavismo movement’s stranglehold of power in Venezuela. In light of this, we find it very prudent for anyone looking to allocate assets to Venezuelan capital markets on the Chavez death news to simply wait for the results of the upcoming by-election.

 

Obviously the key news out of LatAm over the past 24 hours has been former Venezuelan president Hugo Chavez’s unfortunate death at the relatively-young age of 58. We offer our solemn condolences to his survivors and supporters.

 

Per Foreign Minister Elias Jaua, Vice President Nicolas Maduro is poised to take over as interim president of the country while elections are organized over the next 30 days. Technically speaking, per the Venezuelan Constitution, National Assembly President Diosdado Cabello – who fought alongside Chavez in a 1992 coup – is entitled to the powers of the interim presidency, should he choose to wield them.

 

Chavez’s highest-probability potential successors are listed below with the latest hypothetical poll results from an early-FEB Correo poll:

 

  1. Maduro (50%)
  2. Miranda State Governor Henrique Capriles Radonski (36%)
  3. Cabello/other (14%)
  4. NOTE: Chavez had a 64% approval rating in the same poll

 

While the death Chavez – who had nationalized over 1,000 companies during his presidency – represents an opportunity for Venezuela to become less socialist on the margin, it should be stated that two out of the three highest-probability replacement candidates (Maduro and Cabello) do not represent a material departure from Chavez’s socialist agenda.

 

In fact, assuming Chavez was as close to death as we now know he was, the fact that they still proceeded with the early-FEB bolivar devaluation suggests both Maduro and Cabello are still very much on board with Chavez’s hyper-socialist agenda.

 

FAREWELL "CHAVISMO"? - 1

 

To recap that agenda, Chavez has materially devalued the bolivar four times since imposing currency controls in 2003, shut down more than 50 foreign-exchange brokerages in 2010, nationalized farms and energy companies, imposed price caps on dozens of household consumables, routinely used int’l reserves to finance public expenditures and threatened to jail people who trade [currency] in the black market.

 

Such policies have led to shortages of everything from electricity to basic food staples, directly fueling the world’s third-highest inflation rate (+21.3% in 2012).

 

FAREWELL "CHAVISMO"? - 2

 

Capriles represents Venezuela’s highest probability of moving towards the economic and political “right”; unlike Chavez and the vast majority of his supporters, Capriles is from money – his family founded the local unit of Nabisco Inc. and owns the nation’s largest movie theater chain.

 

Moreover, Capriles represents the strongest opposition-led challenge to the Chavismo movement to-date. Recall that his 10ppt. loss in last year’s presidential election was easily the narrowest defeat of any opposition candidate since Chavez took office back in 1999; the previous minimum margin among Chavez's electoral victories was 16ppts.

 

To the extent Cabello doesn’t fall in-line with Chavez’s pre-death wish that Maduro succeed him, you could see an intra-party (United Socialist Party or “PSUV”) struggle for power that could split the Chavismo vote and ultimately result in essentially handing Capriles a victory due to his [likely] garnering of the lion’s share of the opposition vote.

 

On the margin, that would be particularly positive for Venezuela’s structural economic growth outlook and its capital markets (less socialism and Big Gov’t Intervention).

 

That said, however, assuming this scenario is not without a great deal of risk; the data supports a continuation of the Chavismo movement’s stranglehold of power in Venezuela. In light of this, we find it very prudent for anyone looking to allocate assets to Venezuelan capital markets on the Chavez death news to simply wait for the results of the upcoming by-election.

 

Darius Dale

Senior Analyst


MACAU FEB VOLUMES WEAKER THAN WE THOUGHT

We’ve got the property by property detail for the month of February and while GGR grew almost 12% YoY, the month benefited from better luck.  VIP hold percentage was approximately 15-20bps higher than last year and 8-10 bps higher than normal.  Normalizing VIP hold in both periods would have reduced YoY growth to 8%.  While 8% is still solid growth remember that CNY occurred in February of this year but in January of last year.  Mass growth was once again strong, up 31% YoY, consistent with recent trends.  Somewhat troubling and potentially related to the China corruption crackdown, VIP volume growth actually fell slightly YoY.   The aforementioned higher hold boosted VIP revenue up 5%.  The favorable CNY calendar shift did aid slots, however, fueling 17% YoY growth.

 

March looks a little dicey to us on the volume side, owing to a difficult Mass comparison and the China corruption crackdown.  However, low hold in March of 2012 makes for an easier VIP revenue comparison.  Our sources in Macau indicate that the Mass floors are off to a sluggish start.  Operators spread their CNY business over the second half of February thus extending the post CNY hangover.

 

February was a good month for the American operators in terms of market share.  Here are some individual takeaways:

 

LVS

  • Solid market share gains above recent trend driven by a big jump in Mass and VIP
  • VIP hold was well below normal, yet VIP volume and revenue market share improved
  • No surprise that LVS led the market in YoY GGR growth including a 76% increase in Mass growth, highest in 4.5 years
  • LVS should continue to be a market share gainer all year long, absent hold issues

WYNN

  • Not surprisingly, Wynn held above normal on VIP which drove most of the market share growth
  • High hold also boosted Wynn into its first GGR growth month since September, albeit only 4%
  • Mass market grew 16%, its highest in a year but VIP volume fell 8% YoY

MPEL

  • MPEL got hit by bad luck with VIP hold at its lowest rate since March 2011
  • Low hold kept GGR growth at only 1% but Mass rev grew 42% and VIP volume managed a 9% gain
  • Assuming normal hold, MPEL would’ve gained share and posted 16% YoY GGR
  • While there is some concern surrounding MPEL’s dip in share, when you open up the hood you realize that they continue to fire on all cylinders

MGM

  • MGM’s market share gain in the month was exclusively driven by high hold
  • Mass share actually fell to its lowest level ever
  • MGM also lost VIP volume share
  • GGR grew 10% but with consistent VIP hold, growth would’ve been only 6% (VIP hold was high last year too) 

GALAXY

  • Galaxy posted a strong month driven in part by high hold
  • Mass grew 57%, the 2nd highest among the operators
  • VIP volume fell 18% YoY, the 7th consecutive monthly decline
  • Despite the big growth, Mass share fell from recent levels as did VIP volume

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JCP: Duration Matters More Than Ever

Takeaway: Duration matters as much today on $JCP as it did when evaluating it as a short at $40. TRADE = look elsewhere. TREND/TAIL = do the work.

This note was originally published March 05, 2013 at 22:08 in Retail

Conclusion: Pick your duration. It matters -- as much today as it did when evaluating it as a short at $40. If you need to make money in a name before June, don’t look to JCP. The first quarter will be weak, 25% of square footage is unshoppable during the quarter due to construction, and EPS expectations might not be low enough. But if you can you can look to a TREND (2H) or TAIL (3 Yr) duration, we think the risk/reward favors the upside.  Here’s an overview of the incremental changes in our thought process on JCP over the past week.

 

Full Details

We were short JCP since Ackman first brought in Johnson starting in June 2011. The crux of that call was that there was a duration mismatch between the time period Johnson was incentivized to fix JCP compared to how quickly Wall Street was being led to believe (by management and Ackman alike) that a turn would take place.

 

That call worked quite well, but we turned positive earlier this year at $19, however, as we thought that the risk/reward was to the upside and that all the bad news was priced into the stock. That was clearly a wrong assumption. We go through the puts and takes below, but with the downward spiral since the quarter we’re left with the question as to whether we should fish or cut bait.

 

We’re not going to sell into the emotion-fueled debate we see out there today. Instead, we think that the real answer to the buy/sell question is different based on each of our three durations, TRADE (3 weeks or less), TREND (3 months or more), and TAIL (3-years or less).

 

1. TRADE: While we won’t bow to the negativity that’s currently swirling around this ticker, the fact of the matter is that there’s nothing we can point to before June that will make this stock go up. There’s a) the Martha Stewart/Macy’s trial (which could go either way), b) nearly 25% of JCP’s square footage that will be under construction (and therefore unshoppable), and c) the start of JCP’s cash burn into spring while catching up on vendor payables. Package all of this with zero guidance from management on the quarter, and the Street looking for a relatively rosy -7.8% comp in the quarter (a 500bp acceleration on a 2-year basis), and the setup into the May 1Q earnings report is nothing to write home about.

 

2. TREND: Once we’re past 3-months, we think that that the ‘rate of change call’ as it relates to JCP’s top line will start to unfold. Maybe that did not matter as much when the stock traded through $23 in advance of the quarter, but we think it matters at $15. Even if JCP needs to buy the comp, we think that sales trajectory will be the sole factor over a TREND duration that people will care about in answering the question as to whether it actually has connectivity to its consumer or not.  As goes customer connectivity, so goes the stock.

 

For the year, our key modeling assumptions vs consensus are outlined in the table below. Assuming that JCP still runs at a whopping ($2.12) loss per share, we have the company using up $1.1bn of its revolver in order to maintain a cash balance of about $450mm. This assumes a very conservative -$500mm hit to working capital after cutting into too much bone last year, and also assumes no cuts to the company’s $1bn capex plan.

 

JCP: Duration Matters More Than Ever - 111a 

 

3. TAIL: While our TAIL duration is 3-years or less, we’re going to cheat a little bit and take this model out a full 5-years. We think we can get to earnings power starting with a $3 over that time period assuming that JCP only flirts with its former glory when it was simply a ‘bad’ instead of a ‘horrific’ retailer.  Let’s be clear about one thing…we’re not parroting the Ackman earnings power of $14-$22 per share (yes, he actually said that).  But our point is that we don’t need that kind of earnings power for the stock to work over a TAIL duration.

 

JCP: Duration Matters More Than Ever - 222jcp

 

Our Updated Thoughts On Key Issues Impacting The Stock

Here’s an overview of what has changed since the print, where we think were wrong, where we’ve been challenged by investors, as well as our response.

  1. Expectation Mismatch: in reflecting further in the quarter, you don't have to be a genius to see that we got the near term research call wrong. Ironically, for the quarter, we modeled a -35% comp, 24.5% gross margin, and a loss of -$2.50 per share, which is pretty darn close to where JCP came in. Trade receivables were worse than we expected, but net cash on hand was still greater than the $550-$650mm we said we needed to see to prevent liquidity concerns. Our mistake was assuming that these below-consensus estimates were ‘in the stock’. Lesson learned = a large scale negative headline is rarely ‘in the stock’.
     
  2. VNO Stock Sale: The second largest shareholder selling a 10mm share block on the day Ron Johnson was on trial being grilled by Macy’s lawyers about the dispute surrounding Martha Stewart product was tough to see coming. That said the stock traded down over 5% in the session leading up to the announcement – so someone not only saw it, but unethically profited from it. 
     
  3. Timing of Shop Rollouts: If the Martha Stewart trial goes against JCP, we have a very hard time believing the news headlines saying that ‘shelves will be empty’. Rather, we think it’s more likely than not that the product branding or design will need to change in a way to make it clearly not conflict with Macy’s. We don’t think that it will delay the shop opening by more than a month or so, but we think that it could delay the Martha Stewart productivity ramp by 1-2 quarters.
     
  4. Consumer Sentiment: This whole debacle has gotten so much negative press. Check out $JCP on twitter. No exaggeration that 99% of mentions are negative. The company, the management and the brand seemingly has no support – at least by this audience (we trust twitter more than Wall Street sentiment factors in this regard).  Usually such negative sentiment supports a bull case, but the bear case would be that such negativity actually manifests itself in the form of backlash against shopping at the store. In other words, after firing the existing customer and being consistently in the hot seat in front of the American Consumer at large, could it actually prevent the new shop rollout plans from working?  It’s a question that we need to be asking ourselves.
     
  5. How Many Shops Should There Be? We debated this one with several clients, and we think that it’s a very valid question. JCP is reconfiguring 700 of its 1,100 stores. But the question is how JCP arrived at that 700 number. Why not 500? 300? It can do all the studies it wants, but the reality is that it won’t know the appropriate number of stores for this new format until it goes too far. The solace we have from a modeling perspective is that we’ll assume that management has the common sense to start at the very top as it relates to attractiveness and potential likelihood for success. It’s going after 500 over the immediate-term, so it clearly has room to stall or alter capex plans if the data suggests that their 700 estimate is too high.  
     
  6. RJ’s Job Security: Better than 50% of investors we talk to think that Ron Johnson won’t be working at JC Penney in 2014.  We disagree. Simply put, JCP was a horrible retailer before he joined. Then the Board gave him a mandate to change the model. They expected disruption in sales. Did they expect first year sales to be down 25%? Probably not. Did Johnson make some serious errors? Absolutely. But the Board is getting what it asked for – a radical transformation in the business model.

    What are they going to do…fire Johnson and bring in another person to return the company to its former glory? No way. In fact, we think that vendors still hold Johnson in high regard and buy into his vision as to what JCP should become. If he personally ceased to exist in his role as CEO, there’s serious risk to vendors pulling out of JCP en masse to protect their own brands.  
     
  7. Real Estate Value Support: When Ackman did initial storytelling about JCP, he talked up a replacement value of $11bn, or about $50 per share. That’s fine, but there’s a pretty big flaw in that analysis – we’d argue that if JC Penney stores are so grossly underperforming, there’s no need for them to be replaced. Hence we could argue a theoretical replacement value of zero. We can, however, argue something closer to $8-$10 per share. Our assumptions are as follows.

A ) Cap Rates: While cap rates have been drifting lower, JCP would still command among the highest cap  rates due to its sub-prime real estate locations. Let’s assume 8.5% vs Power Center/Strip/Regional Mall average of 7.0%.

B) Rent: Current JCP rental rate is about $4 per square foot on its leased property. It’d be tough to argue something higher than that today. Let’s assume something between $3.50 and $4.00.

C) Combining the two, we’re getting to a value of $8-$10.

 

The key here is not that the portfolio will be liquidated overnight. But rather that it has about $1.8bn-$2bn of near-term liquidity it can access if need be.

 

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Bigger and Stronger America

Client Talking Points

Growth Accelerating?

Back in 2012, we went from #GrowthSlowing to #GrowthStabilizing. Now that America has had some time to digest the move and we're getting awesome labor market and housing reports week-after-week, perhaps we are ready to move to #GrowthAccelerating? Consider this data:

 

  1. ISM Manufacturing New Orders accelerated from 53.3 in JAN to 57.8 in FEB
  2. ISM Services New Orders accelerated from 54.4 in JAN to 58.2 in FEB
  3. PMI Manufacturing New Orders accelerated from 58.2 in JAN to 60.2 in FEB

"Not too shabby," some would say. Well if you combine that with falling oil prices and a stronger dollar, you get growth and an uptick in consumption. That helps drives stocks as consumers flock out to the grocery store, unafraid of what the price of milk may be this week. Things are getting good and they are willing to get better. When that happens, everybody (except the bears!) wins.

 

Asset Allocation

CASH 24% US EQUITIES 24%
INTL EQUITIES 24% COMMODITIES 4%
FIXED INCOME 0% INTL CURRENCIES 24%

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Three for the Road

TWEET OF THE DAY

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QUOTE OF THE DAY

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