two lessons for analysts from JCP

JCP  in the press again over the past two days.

I’ve only seen the headlines, which assert that:

–JCP is trying to sever the 10-year $200 million agreement the previous CEO, Ron Johnson arranged with Martha Stewart.  Why?   …the MS merchandise isn’t selling

–JCP is looking to raise new funds

–a Goldman analyst has used the “B” word (bankruptcy) in warning clients to avoid JCP stock.

I want to make two relatively narrow points:

1.  Analysts are extremely reluctant to speculate on a possible corporate bankruptcy in writing.  They may mention the possibility on the phone or in meetings, but not in print.

A boss of mine years ago at Value Line did this once.  He wrote about a small-cap magazine company that if weak advertising trends continued for the following twelve months, there was a risk the firm would have to close its doors.  Advertising dried up almost immediately on publication of the report.  The company was out of business in three months.

Raising the prospect of bankruptcy is like shouting “Fire!!” in a crowded theater.  It has consequences.

Also, if the firm survives it will never forgive the analyst who made the call.  The Goldman analyst who wrote the report must either be very young or extremely confident that the prediction won’t come back to haunt him/her.

 

2.  In graduate school I spent a year at the university in Tübingen in southwest Germany.  For a while I lived with a family where we all went mushroom hunting on weekends.  What we found made up at least one or two meals the following week.  That’s where I learned about the deaths head mushroom.  Eating it is most often fatal; symptoms only emerge after it’s too late to get treatment.

The obvious course of action–learn what the deaths head looks like, and don’t eat it.

There’s an analogy here.

In the case of JCP, the symptoms we’re seeing now are the direct result of corporate decisions made two or more years ago by ex-CEO Ron Johnson and defended for a long time by Bill Ackman.  Oddly, both seem to have been thinking–contrary to all experience–that falling sales could be remedied by applying a double does of what was causing them.  What’s equally surprising is the the JCP board let the situation go unaddressed until it had reached crisis proportions.

 

My second point:  many times corporate strategies, once put in motion, are difficult or impossible to reverse.  So we, as investors, have to be constantly scanning the horizon for indications of possible weakness. Normally, the early signs of deterioration are found on the balance sheet (rising receivables and inventories) and the cash flow statement.

For JCP, though, there was nothing subtle about its difficulties.  Sales fell apart almost as soon as Ron Johnson took the controls.  Another reason it”s so hard to understand why the board let the situation get so out of control.

 

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