I wrote earlier this month that J.C. Penney's (JCP) disappointing November sales numbers were a sign of worse things to come. The company ended last quarter with more inventory than in 2010, but has been posting fairly substantial year-over-year sales declines in recent months. The bottom line, I argued, was that J.C. Penney's margins would deteriorate far more than the market currently expects, leading to profits as much as 50% below the company's guidance.
Since then, the stock has continued to rise, closing Thursday at $35.19. Ultimately, I think that this move higher is based purely on investors' wishful thinking, and has made the stock an even stronger sell/short candidate. At today's levels, J.C. Penney stock is trading at a greater than 10% premium to Macy's (M) stock, despite the fact that the company's trailing 12 month EPS is less than half that of Macy's. J.C. Penney's valuation is even more absurd given that it has missed guidance more than once this year, whereas Macy's has routinely exceeded its guidance.
There are a couple of potential reasons for recent investor optimism regarding J.C. Penney, but neither is warranted, in my opinion. First, investors are excited about the new management team headed by Ron Johnson [formerly the head of Apple's (AAPL) retail devision and a senior executive at Target (TGT) before that]. It is true that Ron Johnson is a very creative executive, and I am sure that he is developing a solid plan to turn the retailer around. But even those analysts who are confident in Johnson's ability to turn J.C. Penney around believe (for the most part) that it will be a slow process. There is nothing that he, or anybody else, could do to materially improve results this quarter, and his turnaround plan (which will be revealed next month) will only have a minimal impact next year. Given the deterioration the business has seen in recent quarters, this suggests that he will have to dig out of a large hole. Given that the company's balance sheet is not nearly as strong as it was even a year ago, the company is likely to undergo significant pain before it can get back on the growth track, assuming Johnson is successful. Investors are therefore likely to become demoralized over the next few months as they realize that there is no quick fix to J.C. Penney.
The second reason J.C. Penney stock may be going up is that some recent reports suggest that holiday consumer spending may be higher than previously expected. According to the International Council of Shopping Centers, chain store sales (pdf) increased 4.6% year over year last week. For the month of December so far, sales are up a little less than 4% year over year. This may be good news for the retail industry, but it does not necessarily mean that J.C. Penney will see a benefit. For the week of Black Friday, chain store sales were up 4% year over year, and yet J.C. Penney's sales were very weak on Black Friday weekend. (The company did not report exact numbers, but the implication was high single digit declines)
In large part, it seems that J.C. Penney only managed to limit its same-store sales decline to 2% by a relatively strong performance prior to Thanksgiving; i.e. when the company was clearing fall merchandise (and much of the country was experiencing unseasonably warm weather). Ironically, the company's poor performance in Q3 meant it still had fall merchandise that consumers wanted in November. But unless J.C. Penney has done a much better job of interesting consumers in its winter items this month, we could see another significant sales decline in December.
All in all, the facts do not support J.C. Penney's recent move higher. Investors would be wise to avoid or short the stock until the company posts Q4 earnings in February.
Disclosure: I am short JCP.
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