It must come back sometime…” is a common refrain in dealing rooms around the world. Very often it is uttered by those in the process of losing their jobs. We all know that what goes up must come down, but in investing, particularly in the stock market there is no guarantee that the opposite is true. What goes down does not always come back up. Either way, it is always true that you can go broke waiting for something to retrace.
Right now, try as I might, I can find no reason other than “It must come back sometime” to justify buying or holding on to stock in JC Penney (JCP). I wrote my first negative piece on the stock back in September of last year. As hard as it is to believe with hindsight, at the time the general consensus seemed to be that JCP was a bargain at around $13. News had surfaced that several high profile hedge funds had bought into the stock and that, the logic went, was a good sign. The theory then, which seems to be re-emerging now, is that JCP would inevitably gain back some of the losses since 2007. How could an $80 stock stay below $20?
Now, as JCP has bounced off of a well established low around $5 and has hovered around the $8-9 level for a while I am hearing and reading positive noises again. The case this time is at least based on fundamentals rather than the fickle views of hedge funds, but it still seems to be based on “it must come back sometime…” Articles such as this from Reuters have been pointing out that same store sales rose in the first quarter of this year, even as other retailers reported disappointing numbers. The $1.15 loss per share was also not as bad as most had anticipated.
Both of these things are good news, for sure, but in the real world neither is really cause for optimism. The increase in sales came from a disastrously low base, so is not a great surprise. Even more worrying is management’s admission that some of the revenue increase was down to clearance sales resulting in “negative clearance margins”, or, in plain English, selling at a loss. I have owned a retail business, so I understand that this is sometimes necessary, but any resulting increase in sales is not cause for celebration.
Losses are still the problem at JCP. As I said, they weren’t as bad as expected in the last quarter, but that -$1.15 number is still about 50% higher than losses in the same quarter two years ago. Management’s efforts at shoring up the balance sheet have averted an immediate crisis, but borrowing to ease cash flow problems is not a long term solution. In fact, with a debt to equity ratio over 2 and debt as a multiple of EBITDA running at around twice the industry average it looks like simply delaying the day of reckoning. From a valuation perspective the ever increasing pile of debt should be a warning sign for those that believe JCP is a buy based on real estate values alone.
So, if the “good” new about JCP is no such thing and the stock is a sell, what levels should we be watching?
A glance at the 6 Month chart above suggests two obvious targets. A stop-loss to guard against a break back above $10 makes sense, limiting potential losses to around 15%, while a target of a return to the $5.50 levels means looking for a return of around 37%.That risk/reward ratio is appealing.
There is no reason why JCP should return to the levels of the glory days, or even close to it. When the stock was trading at 10 times the current level in 2007 consumers were borrowing like crazy to buy anything and everything and there was still a lot of distrust of online sales. Now, consumers are in the middle of a slow and painful deleveraging process and brick and mortar retail is struggling. Low rates have enabled JCP to keep their head above water by borrowing but even at low interest rates the cost of servicing that debt will be a burden going forward.
Don’t be fooled by the more positive tone of the news, nor the seemingly depressed stock price. When the only reason left to hold on to a stock is the belief that it must come back at some point it’s time to sell, and, when others are in that position, staying short is the best policy.