News Analysis date published New: 
Thursday, May 24, 2012 - 11:30
New Date created: 
Thursday, May 24, 2012 - 12:33
New Date last updated: 
Thursday, May 24, 2012 - 11:30

Warning: Stay Away from this Popular Retail Stock

Thursday, May 24, 2012 11:30 AM

Ah yes... it's 13-F season, the time when investors' fancies turn to what the investment gurus are buying.

Bill Ackman, the legendary value brain behind Pershing Square Capital Management, has been pretty busy these days. With a focused management style that typically involves accumulating large stakes in companies, Ackman has been able to implement changes within major companies and unlock gains for shareholders in the process.

According to his recent filling in fact, he just increased his position in Canadian Pacific (NYSE: CP), securing enough seats on the company’s board to oust the CEO, Fred Green.

But it's his position with venerable retailer J.C. Penney (NYSE: JCP) that's been catching my attention. Let me explain...

Just like with Canadian Pacific, Ackman has been able to make major changes with Penney's board of directors. In November of last year, then-CEO Mike Ullman was replaced by Ron Johnson, Apple's (NASDAQ: AAPL), the brain behind the Apple Store. The result has been a hip, facelift strategy for the old-line department store.

So should you follow Ackman's lead and invest in this department store mainstay?

Well, Ackman's no dummy. Since starting his fund in 2004, Pershing Square's average annual return has been 22%. That's pretty good, considering the S&P 500 has only returned a dismal 1.8% annually in the same period.

But is Ackman barking up the right tree with Pershing's 16.5% stake in Penney's?

Another Target?
In 2009, Ackman mounted a well-publicized proxy fight to gain control over big-box retailer Target (NYSE: TGT). One major platform of Ackman's plan was to bundle up the real estate that the company owned into a REIT (real estate investment trust). Ackman is a value investor with a long history of corporate activism, so with this move, he hoped to unlock cash he felt was buried in the balance sheet.

He embarrassingly failed and retreated to lick his wounds.

Now that Ackman is truly in the J.C. Penney's driver's seat, is he gunning to execute the same strategy? I think he is.

Penney's owns 40% of its real estate locations, while the remainder is secured by long-term leases at rock-bottom rents. His design is to monetize the unused asset and use the cash to enhance shareholder value and to breathe life into the old chain. I totally agree with the REIT-ification strategy of JCP's properties, but I'm not so sure about the hip-ification phase of Ackman's plan, if you will.

Retail's a tough, tough business. The business battlefield is littered with the bones of the fallen, and while J.C. Penney has survived through what appears to be prudent management, Johnson, the new CEO, has really shaken things up.

Pricing strategy has gone from sales and coupons to an everyday low price, rounded-number concept. The logo and all the advertising has a new, fresh look in the vein of Target and Gap's (NYSE: GPS) Old Navy brand.

The company has also changed how it compensates its salespeople. They're now paid a straight salary rather than commission. And that's a big mistake. Sales, especially in a department store, are the oxygen that keeps a retail business alive. Motivated workers do a better job for the company and the customers. Now, all Penney's associates have to do is show up and clock in. Where's the incentive to excel?

Slow turnaround
A shiny new logo, some funky ads and a fresh coat of paint do not a turnaround make. The company reported a $163 million loss last quarter and eliminated its dividend of $0.20 per share. As a result, ratings agency Standard & Poor's downgraded the company's debt to "BB-," which is below investment grade. Meanwhile, Johnson intimated that the turnaround has been more challenging than expected. You think?

I don't mean to be snarky, but the idea of J.C. Penney becoming hip reminds me of your uncle Morty who, obviously suffering a mid-life crisis, pulls up to the family reunion in a Porsche while sporting a toupee and a girlfriend half his age. No one is buying it. There's a big difference in selling iPods to millennials versus blouses to soccer moms.

Action to Take --> Despite the stumble, Ackman continues to pound the table on JC Penny's stock. He's said earnings per share can reach $6 by 2015, which would propel the stock to somewhere between $77 and $125 a share. If the stock hits somewhere in the middle at around $95, then that would be an astonishing 250%-plus return.

If he gets his unspoken wish of spinning off a REIT, then this would be icing on the cake. But I still think Ackman is motivated, this time, by his ego and seeks redemption for his Target misadventure. So if you already own JCP, then consider using it as a source of cash and selling. If you're thinking about adding it to your portfolio, then go shopping somewhere else.

Adam Fischbaum does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.