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JCP: The Board Should Resign

Takeaway: We think that firing RJ at this juncture opens JCP up to risks that were previously not part of the equation. Ullman? Seriously???

After being short JCP from the Ackman/Johnson $40 ‘$9-$12 in earnings power’ hype, we pulled a 180 at $19 earlier this year based on our view that liquidity concerns were overblown, and that the stock would start to turn when the better productivity from the new shops rollout improved the sales delta. Without a doubt, the call was too soon and the subsequent $4/$5 drop in the stock was painful. But the reality is that the research did not change anywhere near as much as the sentiment did, so we kept this name on our Best Ideas list.  But we were vocal several times in saying that the one thing that could make us cut bait on our call is if the Board bowed to Wall Street’s bantering and fired Johnson at this juncture (see our 3/6 Note below “Why Firing Johnson Is The Fastest Way To Ch 11) . Well…Johnson is out, and we're cutting bait. There could be more downside to come.  



This Action Raises More Questions Than It Does Answers

  1. We think that this move is either six months too late, or six months too soon, but definitely ill-timed today.  The Board should fire the guy when either a) his pricing strategies are failing miserably due to botched execution (mid 2012), or b) when the shop-in-shop strategy – the real reason why you hired him – proves to be unsuccessful (end of 2013). Unless there was a dramatic negative turn of events over the past two weeks (which is possible), it is perplexing to think of why they would get rid of him today as opposed to seeing if the shop strategy works. The Board should show a little transparency into its process and personal accountability for its actions.
  2. Mike Ullman is the new CEO, again. Seriously? The stock initially traded up nearly 15% on the announcement that RJ, America’s most hated CEO, was out. That’s about what we’d expect. But once the company disclosed that that Mike Ullman was stepping in, the stock gave up nearly 20%. What does that say about the market’s confidence in Ullman?
  3. Did anyone else even want the job? Mickey Drexler? No way. Alan Questrom? Possibly. But we think he’s smart enough to pass on the job because JCP is so stuck between a rock and a hard place – not having the financial capital to change directions, and potentially lacking the human capital to stay on the existing course set by RJ. The job bank here was really thin.
  4. Lipstick on the Pig? One potential bullish signal would be whether the Board put Ullman in place for an interim period so he can calm the troops, stabilize the business, and put enough perfume and lipstick on the pig so that it can be taken private. We wouldn’t bank on this one, nor would we invest based on it. But we can’t count it out, either.
  5. Capital Considerations: Unless JCP is prepping for a sale, the likelihood of a capital raise just went up – and it went up materially. It’s pretty easy for a new CEO to step up and say “I need money to clean-up the problems caused by my predecessor.”  The reality is that if Ullman wants to go down a new path with the strategy, he will definitely need capital.


We think that the risks we initially highlighted (below) are still very much alive.

We’ve going to let this stock breathe for a bit. After it settles, if the quantitative factors support the call, we’ll have no problem shorting it – even if it’s at a price lower than $14. Real estate value is only $7-$8. And if Ullman can’t pull a rabbit out of his hat on this sucker, there’s no reason it can’t go lower.




04/08/13 05:12 PM EDT



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 [on 3/8] 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).


Today we shorted Freeport-McMoRan Copper & Gold (FCX) at $31.94 a share at 10:07 AM EDT in our Real-Time Alerts. Back to the ole well, FCX is one of our favorite ways to be short the Mining Capex (Bernanke) Bubble. We'll be keeping an eye on the US dollar as well - if it continues to strengthen, that won't bode well for Freeport-McMoRan.


TRADE OF THE DAY: FCX - image001

Missed Our Mining & Construction Equipment Black Book? Here Are 5 Key Charts

Takeaway: Mining capital spending is likely in for a multi-year decline even if commodities flatten. All construction is not US private construction.

Missed Our Mining & Construction Equipment Black Book?  Here Are 5 Key Charts




Below, we show five of the key charts from our mining and construction equipment black book.  You can access the full deck and replay here:






Since mining is a mature industry, capital spending does not need to add much capacity on average.  When capital spending shoots well above trend in a rising commodity price environment, a subsequent flattening (not decline) of commodity prices can lead to dramatic declines in resource-related capital investment.


Missed Our Mining & Construction Equipment Black Book?  Here Are 5 Key Charts - 1r



Currently, mining and other resource-related capital spending is well above depreciation and amortization, a rough measure of long-run steady-state capital spending.


Missed Our Mining & Construction Equipment Black Book?  Here Are 5 Key Charts - 2r



We highlight a number of reasons for the commodity bull market, but investor belief in the commodity bull market is likely a key factor.  Depending on the opinions of strangers may be a risky strategy.


Missed Our Mining & Construction Equipment Black Book?  Here Are 5 Key Charts - 3r



CAT placed emphasis on dealer inventory reductions for recent operating challenges.  The data from CAT dealer Finning and other dealers (as well as CAT itself) suggests that the draw-down may take longer than many expect.  At Finning, it has yet to start.


Missed Our Mining & Construction Equipment Black Book?  Here Are 5 Key Charts - 4r



For those who think of CAT as a construction equipment company (CAT's Construction Industries segment is a much smaller portion of CAT's operating income than either Resource Industries or Power Systems), the US private sector, where construction is actually rebounding from cyclical lows, is only a small portion of the global construction equipment end-market.


Missed Our Mining & Construction Equipment Black Book?  Here Are 5 Key Charts - 6r




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Some volatility in the quarterly numbers but receivables have been consistent since Q4 2011


  • Genting Singapore has said that it was comfortable with the levels of credit it had extended, while MBS has been much more cautious, describing Singapore as the ‘most challenging credit market'.
  • Since jumping from 3% to 6% in 2011, Genting Singapore’s credit policy has been stable at 4.5% of direct RC volume in 2012
  • At the end of 2012, MBS  receivables as a % of direct play was 5%, close to where it started the year, although there was some QoQ variability




Sands China continues to be the most aggressive lender but overall market receivables are down


  • Sands China continues to extend the most credit in the market as a % of direct play, climbing to a record 11.4% at the end of 2012
  • MPEL receivables as a % of direct play fell to 6.9% - a new low for the company
  • MGM China and Wynn Macau remain in the bottom in terms of extending credit
  • The total market receivable as a % of direct play rate fell from the peak in 2Q 2012 to 7.3% at the end of 2012


"Shrinking" The Markets

How Many Investors Does It Take To Change A Lightbulb? – Quantifying psychological drivers of global economy

Hedgeye hosted an Expert Call today with Dr. Richard Peterson, a psychiatrist who also trained as an electrical engineer.  Dr. Peterson has rolled his psychological expertise and quantitative skills into a unique specialty in behavioral market economics.  He is the author of Inside the Investor’s Brain and founder and CEO of MarketPsych Data, where he leads a global team of ten brilliant analysts with diverse expertise developing quantitative models using emotional indicators to identify market trends.


You’re So Predictable!

Dr. Peterson’s work as a psychiatrist showed him there are patterns to human behavior.  His work developing trading algorithms showed that there are patterns in markets.  And, since markets are made up of decisions made by human beings, it wasn’t long before Dr. Peterson started to identify market patterns based on the emotions that go into our decision-making.


In brain scientific terms (don’t worry, this is all we’ll include), strong emotions tend to shut the cortex – the “rational brain” – out of the decision-making system and turn everything over to the amygdala – the instinctive “animal brain.”  If you think this probably leads to poor decision-making, Dr. Peterson would agree 1,000%!


MarketPsych Data, founded in 2004, has developed a massive database of global sentiment, using data derived from social media: blogs, Twitter, Facebook, and a plethora of global forums.  They combine sentiment with reported news to identify trends, asking modeling questions like, How do most people view a political development, and how will that affect a nation’s currency?


MarketPsych’s database draws information from over two million actively monitored news and social media sites, going back to 1998.  It covers over 3,000 sentiment points and individual topics relating to 40,000 separate assets or entities.  The data spans 200 countries, 60 commodities, 30 currencies, and 5,000 individual public companies in 40 different industries.  MarketPsych’s data output is produced in a series of proprietary indices distributed under license through Thomson Reuters, and available by subscription.


If It Feels Good – Don’t Do It!

The big surprise – or not – in Dr. Peterson’s presentation is, whatever you feel like doing, you’re probably wrong.


As laid out in highly readable detail in his book, Dr. Peterson explains that most investors are unconsciously driven by emotions.  In his research, Dr. Peterson asks two questions:

1)      Why are people non-rational in their decision making?  And;

2)     Can we change their approach?


It’s a twist on the old joke about psychiatry: How many investors does it take to change a limit order?  The limit order has to want to change.


MarketPsych’s global team of experts find certain types of news stories spark strong emotions.  Stories around vivid events, with potentially catastrophic outcomes, trigger powerful emotions, especially fear and anger.  And, since the newsmedia report nothing but Vivid Events with potentially Catastrophic Outcomes, Fear and Anger are rampant.


Which is bad for your investment portfolio – but very good for Dr. Peterson and his clients.


Dr. Peterson’s work – and other work available in such recent bestselling books as Thinking Fast and Slow, by Nobel Prize-winning behavioral economist Daniel Kahneman – indicates just how delicate the brain / emotion link is, and how little it takes for the emotions to completely take over our decisions.  Experiments indicate that even a random fleeting glimpse of a photograph of a happy, sad or angry face can have a huge impact on a person’s subsequent decisions.  Imagine how your trading must be affected after you read a headline saying “North Korea Authorizes Nuclear Attack on the US.”


Happy Is The Land

As concrete examples of his work, Dr. Peterson shared some recent strategic insights.  Analysis of national sentiment indicates that extreme sentiments are typically followed by contrarian reversals.  Thus, MarketPsych ranked the top 40 nations on a “country joy index” and built an investment approach around shorting the four most joyful nations, while going long the four least joyful, resulting in a “pairs arbitrage” position.  The reasons markets top out is because everyone has become optimistic.  When the last buyer has gleefully bought into a rising market, there is no one left to take that market higher.  Similarly, when everyone is bearish, that’s when markets make bottoms.   At a national level, the next move for a joyful populace should logically be towards dissatisfaction, and for people who are thoroughly unhappy, there’s nowhere to go but up.


Simplistic as it sounds, the work that goes into building these models is robust, and the outputs continue to be rigorously tested and refined. 


Government instability frightens investors away – leaving buying opportunities for contrarians.  MarketPsych’s country ideas include one-year long positions on Russia and Pakistan (high government instability, looming disasters, low joy).  Meanwhile, currency ideas include a one-year long position on the Australian dollar, in the face of rising commodity pessimism and fears it will wreck their economy. 


Fed Up?

At the national government level, going short trust / long mistrust turns out to be a fruitful strategy.  Shorting a well-respected central bank, while going long a despised one could pay off.  (We leave it to you and your financial adviser to figure out the implications for Mr. Bernanke’s Federal Reserve.)  Significantly, Dr. Peterson’s work indicates low budget deficits are a negative for investing in a country (too much stability).


Perhaps the most graphic depiction of this is a chart indicating that Optimism is one of the greatest enemies of market stability.  MarketPsych provides a graph of the precipitous decline in the S&P 500 index triggered when, in September 2008, Congress rejected the first proposed rescue package, saying the financial sector was strong and did not need bailing out.



"Shrinking" The Markets - ETF congress



On the equities side, Dr. Peterson singled out Carnival Cruise Lines (CCL) – a stock Hedgeye has been negative on.  Dr. Peterson’s work indicates CCL could be an attractive long position: lots of anger, lots of disaster – both actual and anticipated – a company that has fallen from grace and is now almost universally demonized.

Conclusion: The #1 Mistake Investors Make

Dr. Peterson says the single most controversial aspect of his work continues to be the mere notion that our investment decisions are driven by emotion.  For starters, this means you should drop out of that MBA program and get master’s degree in psychology. It also means you are better guided by seeing your shrink, rather than your stockbroker.


One of the key points in Dr. Peterson’s book, in fact, is that investors are willing to pay a premium for professional advice, even when it is consistently average – or even wrong.  Facing powerful emotions all day long takes its toll – ask any seasoned trader.  (Ask any seasoned psychiatrist!)  Writes Dr. Peterson (p. 83) “Investors feel less emotional when deferring some responsibility for financial outcomes onto another.”  This raises the same troubling issue that Hedgeye has been battling since we came into existence: the financial industry is highly conflicted.  Its primary interest is in creating ways to pay itself, rather than coming up with ways to make you money.  Not everyone can be the Smart Money.  But in a field so shrouded in mystery, it doesn’t take much skill to serve as an emotional crutch.


Dr. Peterson says that by far the biggest mistake investors make over and over again is that they hold onto losers far too long, suffering greater and greater losses. 


We would add the Hedgeye Corollary: Most investors hold onto mediocre advice far too long.  Because let’s face it, it’s hard to be wrong about your investments so often.  Much better to have a professional who you pay to be wrong for you.


For more information about Dr. Peterson’s work, please email info@marketpsychdata.com.


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