There are two ways to invest in retailstocks . You can focus
on strong and steady operators such as
Costco (Nasdaq: COST)
and hope to secure moderateupside . Or you can be bold and
buyshares of truly struggling retailers that have fallen deeply
out of favor.
That latter approach has been extremely profitable in 2013 for
anyone with the guts to invest in
Best Buy (
. Just a fewquarters ago, these companies looked to be in deep
trouble as spending on video games and consumer electronics,
respectively, increasingly was taking place at rivals. Those two
retailers have found a way to lure back customers, and the payoff
has been huge.
Major investors are now scouring the retail landscape in
search of the nextturnaround play, and mega-investor George Soros
thinks he's found one. In thisyear 's second quarter, he plunked
down $3 million to buy shares of
J.C. Penney (
at an average price of $16.83. Not only should a purchase of that
size get your attention, but it's also notable that shares are
now 20% lower. You've got a chance to ride herd with George
Soros, at a solid discount.
But should you? This is certainly a company in trouble, with a
great deal of risk. I've already been burned once, noting roughly
a year ago that then-CEO Ron Johnson had crafted a creative
new strategy to help differentiate the struggling retailer from
Johnson's strategy ultimately failed, and the board has
brought back formerCEO Mike Ullman to help stem the bleeding. In
his previous tenure, Ullman wasn't held in high regard by
investors, so the move to reinstate him was a bit curious. The
board knew that Ullman would at least unwind some of his
predecessor's most egregious moves.
Roughly three months ago, my colleague James Brumley helped
frame theissue , identifying the necessary steps to help bring
J.C. Penney back to relevance.
To be sure, Ullman has yet to stop the hemorrhaging. Fiscal
second-quartersales slid 12%, and gross margins dipped below 30%.
That figure, which used to hover in the upper 30s, means the
difference between solid net profits and massive net
losses.Analysts expect the latter, calling for J.C. Penney to
lose more than $5 a share in the currentfiscal year and more than
$2 a share in fiscal 2015.
||With J.C. Penney's shares down 20% since his $3
million purchase, you've got a chance to ride herd with
George Soros, at a solid discount.
But behind the dismal numbers, clear improvements are
underway. In recent months, J.C. Penney has begun to:
- Whittle away at bloated inventories
- Return the assortment of merchandise back to styles and
fashions that formerly devoted customers used to embrace
- Increase the sales emphasis on private label brands, which
should eventually boost gross margins
- Make aninvestment in previous staffing levels, whichwill
hurt margins in the nearterm , but restore the shopping
experience to levels that customers had come to expect
Though these moves notbear fruit in the current quarter,
analysts now think J.C. Penney will eke out a smallprofit in the
all-important fiscal fourth quarter (reversing a $745 million
operating loss in the fiscal fourth quarter of 2013). And
subsequent quarters are expected to show ever-smaller losses,
when compared with the quarterly results being generated this
Such a trajectory is crucial if J.C. Penney is to regain
relevance. The company recently established a newloan agreement
that will ensure it has amplecash on hand through the holidays.
Once better quarterly metrics are in place, management will have
an even stronger hand in refinancing the currentdebt .
Of course at the end of the day, J.C. Penney needs to find the
formula to return to positivefree cash flow ifbalance sheet
concerns are to truly recede. For a point of reference, a healthy
J.C. Penney generated $791 million in positive free cash flow in
fiscal 2010, and a whopping $906 million free cash flow loss in
The Soros Effect
In light of this retailer's challenges and opportunities, George
Soros' massive recent investment in J.C. Penney is notable. He
has presumably looked at the roadmap ahead, and concluded that
new CEO Ullman can stabilize the ship. And stability may be just
enough to justify Soros' interest. After all, J.C. Penney
currently trades at a sharp discount to its peers.
Simply delivering acceptably boring results will close that
valuation gap. Ullman doesn't need to be a hero. Thisstock would
more than double if J.C. Penney is eventually seen in the same
light as its peers. George Soros would be thrilled to see that
gap close by half as much.
Risks to Consider:
J.C. Penney alienated many shoppers with its myriad changes
on the sales floor. It will be a challenge to win back those
Action to Take -->
Recent debt refinancings have given J.C. Penney breathing room,
and as long as the company starts to show progress in stabilizing
operations, then the retailer will be better positioned
withlenders to take any other steps to improve the balance sheet.
This isn't the kind of stock that you want to wait see become
truly healthy interms of quarterly results. By the time that
happens, shares will have already moved up considerable off of
their multi-year lows.