Will the J.C. Penney Rally Last?

by Jeff Reeves | August 21, 2012 12:13 pm

[1]I am a new investor and hope that you can explain to me why J.C. Penney (NYSE:JCP[2]) has gone up after such a terrible report. Other companies miss earning by a penny and they plummet… What is this about, insider buying just to bolster it with shorts on the side? – Edna

Ah, the age old question of why a bad stock goes up when good stocks sometimes go down. This is quite a riddle, but I’ll tackle it the best I can:

For starters, a brief primer for those unfamiliar with the tale of this battered retailer:

• In late 2011, J.C. Penney named Ron Johnson, a former Apple (NASDAQ:AAPL[3]) retail chief, as its new CEO to “re-imagine[4]” the bricks-and-mortar clothing store. And it paid out the nose to get him, a cool $53 million just for signing up[5].
• Penney tried to do away with its addiction to sales and coupons under Johnson’s orders, and same-store sales dropped almost 19%[6]. The company also suspended its 20-cent dividend[7], and shares dropped over 50% from their peak in February.
• Lately, the dust has settled a bit, and JCP has been squeaking higher. It’s up about 20% in the last month or so.

So Edna wants to know what gives. The Reader’s Digest version is that this isn’t a sustainable rally, based on low volume and a bit of short covering. If you own JCP stock you should take the money and run[8].

Here’s the lay of the land in greater detail:

J.C. Penney imploded in May after its ugly earnings report[9]. But about two weeks ago, when it hacked up its second epically bad report. The retailer posted a wider-than-expected loss on a 23% plunge in sales. At stores open a year or more, sales fell 22%. And that’s not even the worst news: Penney actually withdrew its guidance for 2012.

Not a good sign when a company doesn’t even want to talk about the future.

The short-side traders continue to sharpen their knives, too. As of July 31, 56.1 million shares were held short, up from 50.6 million the prior month. That accounts for over 40% of the “float,” or total number of shares actually available for trading when you exclude restricted stock. Not encouraging.

Johnson has made some strategy tweaks that could stop the bleeding, including price cuts[10]. But don’t make the mistake of thinking these moves will do anything substantive to pull JCP out of its tailspin.

My two cents is that some of the recent “rally” has been from short sellers taking their profits. After all, a 50% flop means 50% profits. Furthermore, the suspension of J.C. Penney’s dividend in May means the company is freeing up a boatload of cash in the coming quarters and that could juice revenue or be used to make strategic moves.

That $175 million a quarter isn’t a panacea, but it isn’t chump change, and some short sellers decided to get out while the getting was good rather than suffer a jump in share prices if and when JCP puts this cash to work.

You may be wondering how people betting against a stock can drive it up. Well simply put, short selling is just investing in reverse — selling high first and then buying low. Short traders need to “cover” their sale eventually by buying back shares, and just like a regular buy order pushes stock prices higher by increasing demand for a given company, a buy to cover has the same effect.

So if a lot of people have been shorting JCP — and judging by the 56 million shares on the short side, they have — a lot of people will eventually have to buy back the stock. It appears that some folks have been doing just that over the last few weeks, and since volume is thin, it has briefly pushed JCP higher.

But don’t expect that to last, because once the short-sellers are gone, little buying pressure at all will be left to support this dog with fleas. .

Johnson may turn around J.C. Penney a few years from now. But it’s paying no dividend while you wait, and investors have a host of better options for places to park their money with better hopes of it growing.

Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.”[11] Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.

Source URL: https://investorplace.com/2012/08/will-the-j-c-penney-rally-last/

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