The worrying opacity in J.C. Penney’s earnings

May 16, 2012, 9:55 PM UTC

FORTUNE — The J.C. Penney story isn’t pretty, but it is playing out like it should fundamentally. That’s no surprise to us. On June 11, 2011, Hedgeye made the call on The Closing Bell with Maria Bartiromo: “The Street is at $2.77 [in 2013]. I think they’ll be lucky to earn a buck.”

What did come as a shocker in J.C. Penney’s ugly quarterly earnings announcement Tuesday was how management approached the quality of its results and how it seemed to add every bit of opacity within its grasp. There’s a long time to wait for any signs of momentum (on the upside) here.

After assuring the investment community that JCP would earn adjusted EPS of $2.16 (estimates had been coming down from $2.77), and GAAP EPS of $1.59, CEO Ron Johnson pulled the GAAP number. Earnings in 2012 are going to come in closer to a buck.

The message he left us with is “We’ll still get to adjusted earnings of $2.16 – which is excluding all restructuring charges – but we’re not going to tell you what our GAAP target is. We’ll include restructuring benefits in our results, but not the costs associated with those benefits. As our results change each quarter, we’ll call the delta between what we report and the $2.16 a ‘restructuring charge’.”

Seriously Ron…we’d expect this from your predecessor’s administration. But you? With your high-class pedigree? Someone is giving you bad advice. (See more Ron Johnson: Retail’s new radical)

Let us hit on a couple of items we liked in the quarter.

1) The dividend cut: The reality is that JCP has no business paying a dividend. First quarter cash from operations was –$577 million. Last year it was +$52 million. That’s a $629 million hole. Its cash balance was down $928 million year-over-year. JCP HAD to cut the dividend. In fact, we’d be concerned had they not.

2) It would be disingenuous for us not to state – flat out – that the store concept sounds very exciting. With dedicated shops from brands like Nike, Liz Claiborne, Tourneau, Levi’s, DC Shoes and about 95 other higher-end-than-Kohl’s and even Macy’s brands, this concept has teeth. We still don’t think that the goal of ‘a store for everybody’ is achievable in any way, shape or form. But the store as it is described today certainly has mid-to-upper mass appeal.

3) We still like the bargaining power JCP will have with vendors as it goes about its strategy. Johnson at one point made a comment like “even Gold Toe (Gildan) wants a shop in shop.” They also noted that there will be a very large Levi’s presence, indicating that VFC’s Lee and Wrangler did not make the cut, or play the price cut game required to secure the business. In the end, this is good for JCP. (We still think that the supply chain implications for the rest of the industry are extremely negative).

What we did not like…

1) From the very start of the presentation, management’s attitude was surprisingly cagey. They took the few statistics they they were willing to share, such as average spend and conversion, and attempted to twist them around to suggest that comping down 18.9% had some kind of positive read through. Let’s face some facts: Comping down 20% and putting up a 28% decline in internet sales when Macy’s (M) reported 33% growth in e-tail is just flat-out embarrassing.

2) It would have been so much better for them if Johnson stood up and said “Hey everybody. Let’s get right to the heart of the matter. I realized this quarter that the forecastability of near-term customer behavior and competitive response in this business is much harder than what I am accustomed to. I’m pulling guidance accordingly because I don’t want our team focused on the wrong metrics. I’m going to quantify for you what deviated from my expectations, what I learned, and how I’m changing it.” For a guy with Johnson’s level of integrity, this could have taken an otherwise awful quarter and flipped it 180 degrees.

3) Though we like the store concept in theory as noted above, we have major concerns about execution, capital investment needed to achieve the goals, and the duration mismatch between Johnson and other investors (he gets paid in 6 ½ years when his warrants vest – few investors have that luxury).

4) The company identified additional cost saves – we’re guessing about another $50 million above the previously stated $900 million run rate JCP should achieve by year end (they indicated north of just $10-$20mm). Mind you, this means that it could get to this run rate on Jan 31, and would be a fiscal 2014 earnings event. Nonetheless, when a company puts up one of the most miserable top lines in recent memory, we rarely want to see Retail Austerity to sustain earnings. Management probably reads a statement like this and says ‘c’mon Wall Street…you want earnings and now you tell me not to cut costs?’  Our answer is “Yes. Some people want earnings via cost-cuts today, and they could care less about tomorrow. We’d rather you invest today and crush Kohl’s (KSS) and Macy’s tomorrow.”

5) We have to point out the irony of management’s statement about employee morale, and how “it has never been better” since they switched from a commission to a salaried workforce. So let me get this straight, the employees are happy with sales down 21%? Wow…  Johnson’s point is a good one. A salaried workforce leads to happier workers, which leads to better service, more customers, and perhaps better conversion (though we could argue against that one). In the end he thinks it is a big positive. He’s probably right. But again, we’d note that it is a positive within his 7-year duration – not the 2-3 year horizon by the average long-term investor.

6) The shop-in-shop rollout will take time. Johnson is planning on rolling out 2-3 shops per month through December 2015 until JCP has reached 100 overall. Right now, we know of about 30 of these shops. Additionally, there seems to be no lack of interest, as JCP received 110 applications from brands interested in partaking in the new concept. Though the actual rollout may consist of 2-3 brands per month, our sense is we will be introduced to those participating in the “shops” in larger groups well ahead of their actual rollout not unlike we were yesterday. Assuming JCP maintains the 2-3 shop schedule, the rollout and ensuing change to the merchandise assortment could looking something like the roadmap below with 100% of the assortment refreshed come 2015 (47% will be changed by this August).

We’re at $1.00 per share for the year, and $1.75 in 2014. Timing is a very important consideration. If the company gets closer to $2.16 in 2014, then people will look towards a number above $3 another year out as the excitement around a big comp rebound and associated leverage ensues. That would, in fact, be an exciting story. But the absolute earliest there will be any form of visibility into any such rebound happens well into 2013. In the meantime you’re paying 15.2x a made-up non-GAAP EPS number that might or might not materialize before 2014. We can think of dozens of other places we’d rather be.