The Case for JC Penney

It’s hard to watch JC Penney’s CEO, Ron Johnson, give his presentation yesterday without feeling a tinge of excitement that we’re at the beginning of something new in retailing. His absorbing performance promises a new paradigm in retailing. Turning around JC Penney (JCP) won’t just be a question of spending ad dollars more wisely or weaning customers off perennial discounts, but will ultimately transform the shopping experience.

When Ron Johnson joined JCP he spent $50 million on 7.5 year warrants ($29.92 strike price, 7.3 million shares) that he’s not allowed to hedge for six years and received $50 million in restricted JCP stock, as well as walking away from around $70 million in stock in Apple (AAPL), his previous employer. Much of his prior team has joined him on this new quest. It’s exciting stuff.

We own JCP in our Deep Value Strategy. Reading through prior investor presentations, after Ron Johnson joined but before he’d begun to communicate his vision, was underwhelming. Buying JCP back then represented an act of faith that the man who led AAPL’s retail strategy, hand-picked by Bill Ackman, could perform some magic on a dowdy retailer. Looking like the late Steve Jobs without his trademark black jeans, Ron Johnson provided plenty of reasons to get excited about owning JCP.

Transforming the company will take several quarters to even begin to show financial results. No doubt there are enormous differences between selling AAPL’s proprietary products, and changing retailing while your competitors watch and quickly emulate your best ideas. But in the meantime, the bear case will have to survive without the benefit of disappointing financial results to shake out the bulls. And it’s not hard to imagine hope and a little reflected stardust from Ron Johnson’s prior employer adding some rocket fuel.

Our JCP holding is an investment, and the upside is sufficient that we’ll likely hold it for a long time to see how the story plays out. Although JCP’s earnings multiple is high, it trades at 0.5 X next year’s consensus revenues compared with 0.55 for Macy’s (M) and 0.64 for Kohl’s (KSS). There seems little point in being short JCP at anything less than industry revenue multiples. Nordstrom (JWN) trades at 0.97X. As of Dec 30,  20% of the float was short, and those must be weaker hands than many of the longs. For now, the bulls are in charge at JCP.