J.C. Penney’s bleak future

I have followed the failures of J.C. Penney, the giant American retailer, over the past year with a kind of morbid fascination. The hiring – and then firing – of former Apple marketing whiz Ron Johnson only added to the titillating storyline associated with the company: a one-time retail champion fallen on hard times that makes one bold, last-ditch effort to right the ship.

As early as last summer, JCP’s Altman z-score, an academic measure of solvency often used for its predictive power of future bankruptcies, fell well within the distressed category, and around 80% of such companies file for bankruptcy within 24 months. Johnson’s ill-fated turnaround strategy put further pressure on the company, as revenues fell precipitously as a result of Penney’s move away from coupons and discount racks, alienating its already diminished customer base. In short, the company’s base retail operations are a train wreck, not a good sign for a retailer that has entered the dreaded zone of uncertainty.

For Penney, it’s not really a matter of hoping the cash reserves hold out. Without some signs of operational improvement, the company is doomed. It will continue to burn through cash until the inevitable reckoning occurs, and hiring on the man that Johnson replaced – former CEO Myron Ullman – is not really the answer investors were looking for. If Ullman was the answer, he wouldn’t have been shunted aside in the first place.

Bankruptcy seems an obvious destination; however, I’m not quite sure what Penney would gain from Chapter 11. Lightening the debt load certainly wouldn’t hurt, but with total debt to equity standing at 94.04, it’s not the debt that is crushing the company. After all, other retailers (Macys comes to mind) carry more debt, but are thriving nonetheless. What’s crushing the company is that no one wants to shop at its stores, and that is something that bankruptcy won’t solve.

Factor in as well the presence of shareholder William Ackman, whose Pershing Square Capital holds roughly 18% of the company. It was Ackman who was chiefly responsible for the Ron Johnson debacle. As JCP’s options begin to narrow, you can rest assured that Ackman’s attention will shift from saving the company to saving himself. A bankruptcy would surely put Ackman’s equity stake at risk, and as The Deal noted earlier in the week, one can safely assume that Ackman will try to avoid that eventuality at all costs.

But it’s hard to see an alternative to bankruptcy at this point. Some believe that the company has enough “brand equity” to court outside investors once the stock begins its inevitable descent; however, such a concept is fraught with uncertainty. Given the way the term is used, I often feel that folks confuse “brand equity” with something more neutral, “name recognition.”

The fact is that JCP’s current brand positioning skews into the negative; it is more likely to be a place where people actively avoid shopping. I would wager that JCP could adopt a defunct retailer’s brand name (like Thalheimer’s), re-brand its operations, and be ahead of where it is now – that’s how little goodwill and esteem the brand holds. If such a state can be considered “equity,” then the whole concept of brand equity needs to be rethought.

So what can be done?

It’s really a tough predicament for JCP. At this point, the first step is to admit that the company is not viable in its current configuration. Embracing that reality should create the necessary appetite for radical change. The easiest path that I can see is for JCP to greatly decrease its footprint by selling off all marginal properties in order to raise cash and improve operating performance. Once that process is under way and generating cash, the company should throw its remaining resources behind a web-based strategy to push its private brands, using the successful online retailing platforms of Amazon and others to augment the remaining JCP store locations and its own website. So, in a sense, I guess I am advocating that JCP transform itself into a direct-to-consumer retailer cum middle-brow fashion house, while retaining only the profitable rump of its current retail stores. Rather than trying to remake itself in the mold of a Macys or Target, JCP should look to Fifth & Pacific (formerly Liz Claiborne Inc.) for inspiration.

Farewell, Mrs. Thatcher

For a kid growing up in the 1980s in a very politically conservative family and in a very conservative region of the country, Britain’s Margaret Thatcher, along with Ronald Reagan and Pope John Paul II, formed for me a kind of Holy Trinity of leadership. All three stood against the results of Progressivism and sought in their own way to roll back the excesses of the 1960s and the malaise of the 1970s.

With the passing of Mrs. Thatcher Monday, the conservative troika has now passed into history.

Her passing has been voluminously covered by both friends and enemies over the past few days, and I won’t aim to summarize what is readily available elsewhere; however, it is interesting to see the reactions of those folks who were too young to remember what came before Mrs. Thatcher, as well as those my own age who do, or should, remember the 1970s.

One thing that I learned from my 15 years in New York City is that there will always be a contingent of people with what I call “a longing for the gutter,” that is, a kind of nostalgia for misery. If unlucky enough to pass youth’s formative years in a dysfunctional pigsty, it is of no consequence for the nostalgist, who often demonstrates a surprising capacity to romanticize squalor and disrepair, if that be necessary to capturing – or recapturing – one’s youth.

So it is with many New Yorkers who still maintain that Abe Beame’s City surpassed all, despite its rampant crime, fiscal ruin, public-service woes, and scenes borrowed from a Hollywood disaster movie. So, too, do many Britons wax poetically about pre-Thatcher Britain. I guess that’s why I found Ian McEwan’s piece on The Iron Lady in The Guardian so refreshing. Most of the things I’ve read from the left about Thatcher’s passing have downplayed the state of Britain prior to Thatcher’s stint as prime minister and focused instead on the policies they so loathed. So kudos to Mr. McEwan for at least describing the country that Thatcher sought to change:

“But if today’s Guardian readers time-travelled to the late 70s they might be irritated to discover that tomorrow’s TV listings were a state secret not shared with daily newspapers. A special licence was granted exclusively to the Radio Times. (No wonder it sold 7m copies a week). It was illegal to put an extension lead on your phone. You would need to wait six weeks for an engineer. There was only one state-approved answering machine available. Your local electricity “board” could be a very unfriendly place. Thatcher swept away those state monopolies in the new coinage of “privatization” and transformed daily life in a way we now take for granted.

“We have paid for that transformation with a world that is harder-edged, more competitive, and certainly more intently aware of the lure of cash. We might now be taking stock, post credit crunch, of our losses and gains since the 1986 deregulation of the City, but it is doubtful that we will ever undo her legacy.” 

While Mr. McEwan and I would surely disagree about undoing Thatcher’s legacy, I find myself agreeing with the more cosmetic criticisms of the contemporary period ushered in by late-20th century conservative politics. For instance, when walking through the winding streets of New York’s SoHo neighborhood, it is difficult to feel any sense of accomplishment in having turned SoHo into an outdoor mall lined with the signage of luxury consumer goods. Nor is it pleasing to consider the proliferation of residential skyscrapers and luxury condos that threaten to turn all of Manhattan into a playground for the rich and famous. I’m sure long-time Londoners have many of the same complaints.

Perhaps the mistake is in thinking that the poles of recent history are our only choices – are we fated to choose between the apocalyptic wretchedness of the 1970s and the bland consumerism of today? I admired Mrs. Thatcher because she labored ceaselessly to increase the freedoms we enjoy: the freedom to enter into (or avoid) business relationships, the freedom to deploy our capital in our own manner, and the freedom to remake or demolish parts of the state that simply don’t work. What we do with that freedom, however, is quite another matter.

CNBC: J.C. Penney fires CEO Ron Johnson

During the first quarter, I have followed the travails of retailer J.C. Penney with great interest and suggested that the outlook isn’t likely to improve in the near term. Despite a few analysts who claimed to see a silver lining in the company’s recent woes, the marketplace has shown no real faith in the direction charted by CEO Ron Johnson. Today, the company’s board seems to have concurred with the market, firing Johnson after 16 months on the job.

TD Bank’s status: TBD

The Wall Street Journal’s Suzanne Kapner posted an interesting look at TD Bank earlier this week examining TD Bank’s formerly strong reputation for customer service and loan underwriting. The article suggests that the bank’s recent run of acquisition and expansion has damaged its standing among consumers. The article covers pretty well the damage TD Bank has done vis-à-vis customer service, although in my recent dealings with the bank, I have found TD Bank to be pretty good. On the underwriting front, however, there may be some smoke.

In the Journal article, one bank spokesman described TD Bank’s approach as “low risk,” but here in South Carolina, I had one astute buyer’s agent actually recommend the bank to me for a mortgage because it was perceived by her to be “easy.” On the one hand, it’s great that TD Bank has shouldered its way to the top of the list in a market where it has only recently planted a flag; however, on the other hand it seems possible that it has degraded its loan standards in order to secure business.

The most interesting tidbit from the WSJ piece concerns TD Bank’s ongoing branch expansion. The prevailing wisdom (at least, as told by management consultants) is that the advent of online banking and smart-phone apps will result in massive “channel switching” over the next decade whereby customers forgo their ritual visits to a bank branch and instead take to the web to conduct transactions. While such behavior is generally more efficient, there is the little problem of all those underutilized branches. What will become of them? Or more accurately, how quickly and how well can large banks shrink their branch network if and when channel switching picks up real steam?

According to Kapner’s article, the summary impression is that TD Bank seems unconcerned with this phenomenon. The bank has expanded its locations by 23% in the last five years and apparently isn’t content with that:

“TD recently opened its 100th branch in New York City, making it the sixth-largest lender in the Big Apple by retail outlets and the fifth by a measure of retail deposits known as capped deposits. TD has plans to open 50 more branches in New York City and become No. 3 in capped deposits by 2015. Similar expansions are planned for parts of Florida and Boston.” 

Expanding in New York and Florida is one thing, but I recently passed through the small town of Swansea, S.C. (pop: 844) and to my surprise gazed upon a small branch wedged between the railroad tracks and one of the town’s few traffic lights. Clearly, TD Bank is taking a contrarian position in the Great Branch Debate.

The Journal article suggests that the genesis of TD’s aggressive move south of the border was before or during the financial crisis. With so many giant banks ailing, perhaps CEO Ed Clark saw a clear opportunity to fill the vacuum, but the article goes on to quote a financial industry analyst who feels the low hanging fruit is gone, particularly since competing banks are purportedly returning to health. Mr. Clark is due to move on and retire soon, and while his appointed successor is hewing to the same strategy in his public comments, I bet he is giving serious thought to putting the brakes on expansion.

The Journal article cites an interesting figure:

“TD’s profitability has lagged behind that of many of its peers, and the company’s once-sterling reputation for customer service has declined since the 2008 purchase of Commerce.

“Although TD Bank NA’s net income increased 14% in 2012, to $775 million, compared with $681 million earned the prior year, 90% of its peer group earned more, according to the Federal Deposit Insurance Corp. TD says the numbers reflect in part its low-risk strategy.” 

Now TD could be right, I suppose, but like I mentioned above, my own experience suggests that whatever conservative underwriting strategy was in place might not be the norm anymore. If that’s the case, then TD’s laggard performance isn’t the result of caution, but just managerial ineptitude. The bank has gotten quite large quite fast; it wouldn’t be the first time that a bank has suffered due to rapid expansion (for years Bank of America was a poster child of too much too fast).

Investors will likely be deterred by the specter of over-expansion and revenue malaise. After all, since the beginning of September 2012, TD’s stock has lost 2.8% while the S&P has set new highs, gaining over 10% during the same time period.

Personally, I love TD Bank. I use its discount broker and have a mortgage with them; however, I’d have to warn investors to stay away, or at least, take a wait-and-see attitude. The bank seems committed to a strategy that has led to under-performing results, and with potential challenges to branch profitability on the horizon, it could yield worse results yet.

The big bang theory of personal finance

It is hard these days to avoid an airing of The Big Bang Theory. The immensely successful situation comedy pulls in huge ratings for CBS in its Thursday time slot, but more importantly, it has been syndicated and now features as a staple of multiple cable channels, sometimes airing several times per evening. I don’t mind the show; in fact, I kind of like it, though with such frequent exposure, sometimes it’s hard to tell if I really like it or if I’m suffering from a TV version of Stockholm Syndrome. Of course, I could change the channel or just turn off the television, but I watch TV when dining at home…so it goes.

The show takes a Los Angeles cliché and adds a little twist: two incredibly nerdy Cal Tech physicists live across the hall from a bombshell neighbor who works as a waitress while harboring aspirations of breaking into show business. Around this simple premise the show’s creators have sprinkled in the pixie dust that draws in viewers: heaping helpings of nerd sub-culture and an unlikely romance between our blonde bombshell and one of her physicist neighbors. Thus, the show taps into a demographic that has yielded incredibly fanatical followings (Star Trek, Apple computers), as well as involving the tried-and-true formula of a long-term, on-again-off-again romance (call it the ‘Sam and Diane’).

Unlike Cheers, however, The Big Bang Theory’s primary setting is home, not work (although there are plenty of visits to The Cheesecake Factory and the Physics Department). Because so much of the show occurs in the domestic setting, we learn a lot of detail about the main characters, and as with anybody, money plays a big part of the characters’ concerns and actions. Unfortunately, you learn not to press too vigorously against the show’s premises, because once you begin examining the personal finances of the main characters, suspending disbelief becomes all but impossible.

For instance, as young (around 30 years of age) Cal Tech physicists, the Leonard and Sheldon characters can expect to make collectively anywhere between $125,000 and $200,000 per year. On the other hand, Penny, our aspiring actress, can expect to earn anywhere from $15,000 to $20,000 a year as a waitress (California’s minimum wage is $8 per hour). She is portrayed on the show as a “community college dropout” and often borrows money from across the hall. In one episode, her monthly debts to Leonard totaled over $1,400, roughly equal to one month’s income. The itemized list of debts suggested that her rent was the lion’s share of that total; for argument’s sake, let’s say $1,300, which would be a steal for a nice one-bedroom apartment in Pasadena (according to Apartmentratings.com, such an apartment goes for between $1,706 and $2,464). It doesn’t take long to understand that the math doesn’t add up.

Given the show’s large viewership, I’m sure such an observation is not new; however, what interests me here is how such a portrayal of reality might actually be driving the show’s audience. To any member of the Millennial Generation – that is, 20-somethings who have had a very difficult time finding employment and who often carry crushing student loan debts – the life of Penny must immediately strike them as a fairy tale. No roommate, no real job prospects, no problem. Unless the Penny character is receiving aid from her parents or has a large trust fund, her life in Pasadena, as portrayed, simply isn’t possible. Maybe the fairy-tale aspect appeals to a generation of people who find that, after enjoying the increasingly resort-like existence of the university, they all too often have to move back in with their long-suffering parents.

Furthermore, when you begin to parse the ratings data for The Big Bang Theory, you begin to suspect that the fantasy isn’t exclusively (or even predominantly) for Millennials. The Big Bang Theory’s early March ratings garnered a 9.7 share in overall households and a 6.1 share in the 25-54 age bracket; however, as you progressively hone in on younger viewers, the audience dwindles – the show received only a 3.1 share among 18- to 34-year-olds. Now there are a lot of explanations for this. Perhaps young adults watch less TV, or perhaps the audience is far more fractured than older audiences and more apt to watch content on mobile devices, computers, etc. Also, CBS traditionally does better among an older demographic. But, just maybe, Millennials find the show less relevant to life as they know it, particularly after the hard post-college lessons many have had to learn. Maybe it’s the older demographic that is really driving the show’s ratings.

After all, there is a comforting kind of nostalgia baked into the premise of The Big Bang Theory. For a generation raised on Sixteen Candles and The Breakfast Club, the notion that a successful knowledge-worker (as we called them today) can hook up with the prom queen college dropout is familiar and speaks to the subversion of class identity that was a staple of John Hughes films.

The reality, however, is that Americans who have advanced degrees increasingly seek out each other as mates. The fictions of our youth might have steered the good girls to the bad boys, or the jocks to the plain Janes, but there would appear to be far more deterministic forces at work in the real world, and as often as not, those forces are guided by factors that privilege education and income over most else. Perhaps it’s part and parcel of a world where people with similar political convictions are increasingly neighbors and parishioners, or perhaps it’s aided by the cyborg-like intelligence we tap into on dating websites in order to find the “perfect” partner.

Whatever the answer, I suspect folks will continue tuning in to The Big Bang Theory, but despite the Comic-Con and video-game references, it might not be the folks you would think.

Penney gets support from Morningstar analyst

Morningstar posted today an analysis of J.C. Penney that should give the retailer a shot in the arm. Unlike my take on the struggling retailer that I posted last month, Morningstar’s Paul Swinand sees evidence that Penney CEO Ron Johnson’s turnaround plan is bearing fruit. Swinand writes:

Despite the Street’s growing pessimism, we continue to believe that the turnaround at J.C. Penney can work for three principal reasons: the speed at which the company has been able to change, including the reduction of $1 billion in annual costs; the increased productivity of new shop-in-store installations; and broad-based improvements in merchandising (which we believe have been overshadowed by management’s pricing and promotional strategies the past year). Although we believe it will still take time for J.C. Penney’s turnaround to fully play out, we believe shares are undervalued relative to our $27 fair value estimate, based on our recent store checks focusing on shop-in-store productivity and conversations with management. 

Morningstar’s fair value estimate would imply a market capitalization of about $6 billion for Penney, a figure that is hard to swallow. The stock hasn’t touched such levels since the end of Q3 2012, and given that most analysts expect the company to continue losing money well into 2014, it’s hard to see Morningstar’s fair value holding any water.

As I said last month, I do believe that Johnson’s turnaround plan has some time to get things right, but the weight of evidence suggests that a slow slide into restructuring is more likely. I’ve seen nothing in the last month that would suggest Penney is a comeback stock for retail investors, despite Morningstar’s upbeat analysis.