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Market Update

JCP Transformation Still Needed After CEO Departure

Although we continue to hold out hope that the no-moat retailer can turn around, we believe that this latest move increases uncertainty and adds additional management distractions at a critical time, says Morningstar’s Paul Swinand.

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While we knew  J.C. Penney (JCP) CEO Ron Johnson could be on borrowed time since producing more than a year of large sales declines and negative earnings, we can only take his sudden departure last night as a sign that the first quarter will show another largely negative financial report. The J.C. Penney Company board announced the appointment of Mike Ullman to the post, the CEO that Johnson replaced in 2011. Although we continue to hold out hope that the no-moat retailer can turn around, we believe that this latest move increases uncertainty and adds additional management distractions at a critical time. 

We also highlight that the retailer was not left in great shape when Ullman left. The nearly 600 sales events a year with discounts often exceeding 60% all took place under his tenure, and the company's SG&A expenses were higher than those of its department store peers. One positive we find in Ullman's appointment: he has no employment agreement and his salary will be just $1 million per year. We also assume that he won't be commuting to Silicon Valley, since he still is listed as owning property in Dallas. To us, Ullman is motivated by something potentially more powerful than money: he's doing this to turn around his reputation and hopefully to eventually leave on his own terms with a high note. There is no change to our $27 fair value estimate based on this announcement, though there could be changes to our long-term valuation assumptions and/or uncertainty rating as Ullman's plans for the company become more apparent.

Johnson has taken plenty of criticism for his 2012 performance at J.C. Penney, now branded "JCP." We see two of the most important mistakes as 1) a pricing strategy that changed nearly every quarter, and 2) marketing which was edgy but alienated customers. Although Ullman has made some brief statements following his appointment, we don't believe the company can go back to where it was under him, but at the same time it is critical that he find a way to stop the bleeding before back-to-school season and into the holidays. The company ran some sales and coupons in the first quarter, but with 30% of more than 600 stores under construction of a new Home department, we believe Johnson was slow to throw the promotional switches, which might sound ironic since he was so quick to implement changes in 2012. Given the branded vendor strategy, and vendor contributions to in-store shops, Ullman cannot just slash prices on national brands.
Another important point, in our view, is that although Ullman is presumed to know the company inside and out, substantial management changes took place under Johnson's watch, and many operational changes have already happened or been set in motion. The company has cut nearly $1 billion in overhead costs, including $350 million at headquarters and $150 million in marketing. We're not so sure "cheers went up in the halls" in Dallas since many of the executives and managers were loyal to Johnson and his team. CFO Ken Hannah commented recently that despite over 800 custom IT systems and reams of paper reports, there was no way to analyze merchandise that was out of stock. It seems odd to us that an executive with Ullman's 25 years of high-level retail experience, including leading Macy's, didn't have an easy-to-use out of stock report to discuss with merchants each Monday morning.
We also believe that although Ullman has no employment agreement (and may effectively be an interim CEO, in our view), the board should consider making him a permanent offer. Merchants and a retail organization cannot change leadership too often and be successful in our opinion, particularly at a time when fresh new looks and merchandise are trying to be given a chance to work. Middle managers and merchants who have stayed must not shift into "survivor mode," where no one is willing to take risks, and where the most talented people leave first. In addition, if Ullman departs on bad terms, J.C. Penney will start to face a situation, not too dissimilar to  Sears (SHLD), where new CEOs are hard to attract and don't last long. 

Taken together, the near term looks as cloudy as ever, and the new strategies and merchandise may be put at risk with this move. Ullman's challenges are great, but our hope is that he can be both a diplomat in bringing people together, and also be decisive yet correct when addressing the challenge of attracting back old customers. Still, we hold that continuing to refresh the merchandise and store environments is critical, as the old J.C. Penney stores were not part of an attractive long-term business model.

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Paul Swinand does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.