J.C. Penney CEO Touts Towels, Cookware to Stem Losses

J.C. Penney Co.’s widening loss and falling sales last quarter show that Chief Executive Officer Mike Ullman is still plagued by his predecessor’s missteps as the retailer prepares for the crucial holiday shopping season.

While hedge-fund investors including J. Kyle Bass are betting the retailer will recover, Ullman is struggling to preserve cash and woo back alienated shoppers by reversing some of the changes ushered in by former CEO Ron Johnson.

The Plano, Texas-based department-store chain said it planned to close some of the home-goods boutiques from the Johnson era, though it declined to say which ones. To improve results, J.C. Penney will devote extra floor space to towels, cooking utensils and more profitable categories such as luggage and window treatments.

“The third quarter is make or break,” Liz Dunn, an analyst at Macquarie Group in New York, said yesterday in an interview on Bloomberg Television. She rates the shares neutral, the equivalent of a hold.

Analysts estimate J.C. Penney will continue to post losses in the next four quarters, each loss smaller than the results the chain reported yesterday.

Daphne Avila, a spokeswoman for the retailer, declined to comment for this story.

Ullman is saddled with vestiges of his predecessor’s strategy, which involved turning the stores into mini malls of branded boutiques, that were too far along to abandon.

One of Johnson’s biggest initiatives was a more upscale home department selling designer goods such as $60 toasters from architect Michael Graves and big-ticket goods including a $1,695 chair from Happy Chic by Jonathan Adler. Such items aren’t resonating with J.C. Penney’s middle-market customers and sales at stores open at least 12 months fell 12 percent in the second quarter.

‘Major Obstacle’

“Our underperformance in this area has been a major obstacle in the turnaround effort,” Ullman said during an analysts’ conference call yesterday. “It was apparent quickly that the merchandise wasn’t resonating with our core customer, and performance is weaker than we hoped.”

The company plans to sell low-priced items such as towels in the wide aisles in the home area, part of Johnson’s vision to create a main street aesthetic, and turn test kitchens, also part of the former Apple Inc. retail head’s overhaul, into cookware shops.

J.C. Penney also needs to clear out the merchandise that isn’t selling. During the second quarter, discounting reduced gross margin, or the percentage of sales left after the cost of goods sold, to 29.6 percent from 33.2 percent. The net loss expanded to $586 million, or $2.66 a share, from a deficit of $147 million, or 67 cents, a year earlier, the company said.

‘Tricky’ Season

This holiday season, balancing promotions to drive sales and profitability will be “tricky,” said Rick Snyder, an analyst for Maxim Group LLC in New York, who recommends buying J.C. Penney shares. The focus should be on persuading as many people as possible to visit stores, Snyder said.

“If the customer doesn’t come back, it’s not going to work,” Snyder said. “It’s that simple.”

The shares fell 4.9 percent to $13.33 at the close in New York. The stock has sunk 32 percent this year, compared with a 15 percent advance for the Standard & Poor’s 500 Index.

Since his arrival in April, Ullman has slowed the sales slide by stepping up discounts and bringing back private-label merchandise that appeals to core customers. During the second quarter, revenue declines improved each month. The trend will continue through the rest of the year and results from the early part of the back-to-school season also were encouraging, J.C. Penney said.

Ackman Criticism

This month, Bill Ackman, the company’s largest shareholder, urged the board to replace Ullman earlier than planned. Ackman has since left the board and won permission to gradually unwind his stake.

Over the past two weeks, Bass, who focuses on corporate turnarounds, has accumulated a long position by buying the company’s secured loans, according to a person familiar with the matter. The 43-year-old founder of Dallas-based Hayman Capital Management LP is betting J.C. Penney can stabilize sales and has enough cash and credit to carry it until the 2014 holiday season, said the person, who asked not to be named because the information is private. In the hedge-fund manager’s view, the company’s apparel business is rebounding and it is sitting on valuable real estate, the person said.

J.C. Penney’s creditworthiness is greater than major bond-rating companies estimate, according to data compiled by Bloomberg, evidence supporting Bass’s debt purchase.

Soros Fund Management LLC, Perry Capital LLC and Glenview Capital Management LLC also have taken stakes in J.C. Penney.

Preserve Cash

Besides winning back shoppers, Ullman will have to preserve cash. Earlier this month, analysts including JPMorgan Chase & Co.’s Matthew Boss said the retailer was using so much cash it may need to seek more outside funds by the end of the year. J.C. Penney said it expected to end the year with more than $1.5 billion in liquidity and that the forecast doesn’t assume outside financing.

Within three weeks of returning, Ullman drew down $850 million of the company’s revolving credit line and negotiated a $2.25 billion loan. It pays interest at 6 percent, according to data compiled by Bloomberg. The debt was quoted at 95.5 cents on the dollar yesterday, down from a high of 101.9 cents on July 23, according to data compiled by Bloomberg.

Given the company’s use of cash, “things really need to turn quickly in the third quarter,” Dunn said. “I didn’t think they had a shot to do it in this second quarter.”

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