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The Not-So-Crazy Case for JCPenney

JCPenney (NYSE:JCP) will report earnings on Feb. 26, and after some rather brutal figures for the past several months, investors can probably expect another lackluster showing. JCP is now down 50% in the last year while the S&P 500 is up 15% — fellow retailers Target (NYSE:TGT) and Macy’s (NYSE:M) are up even more than that.

But after JCPenney stock has crashed and after watching same-store sales decline at least 20% for three consecutive quarters, it might be time to consider the worst over in this struggling retailer.

I’m not saying JCPenney is a buy at $20. My look at the last few months of action hints that resistance is lurking in the $18 range. But if JCP drifts down 10% or so into that territory, it could be a bargain buy.

Here’s why I think JCPenney stock has stabilized, and why I think it might have some upside before the year is out:

Why JCP Has Stabilized

Improving Fundamentals: While the February earnings report will mark the end to an abysmal fiscal 2013, it also should usher in a new fiscal year with higher expectations. Standard & Poor’s estimates FY2014 EPS of $1.15. Also, revenue is supposed to flatline with a roughly 1% decline — not great, but a sign of stability after a projected 23% decline in sales for FY2013.

Coupon Comeback: After much flip-flopping on the issue, JCPenney will continue to feed the beast using targeted storewide sales — a move that’s counter to previous efforts that rolled back discounting and coupons and alienated core JCP customers. Sure, coupon addiction isn’t a good thing for your customers … but at least by allowing discounts to continue, Penney will stop the bleeding on same-store sales.

The Shop Model Has Promise: CEO Ron Johnson of Apple (NASDAQ:AAPL) retail fame deserves a lot of criticism for miscues and an over-inflated, front-loaded salary. However, one idea he has put into action with great results is the “shop-in-a-shop” concept. Consider dedicated Levi’s real estate, a kind of denim boutique, which tallied double-digit comps to the overall men’s department back in September. Izod, Liz Claiborne, Sephora, Dockers, even Disney all have signed on — and these brands are showing signs of life. While the shop-in-shop growth hasn’t been able to offset an overall crash in store traffic due to aforementioned confusion over coupons and discounts, the potential here is noteworthy.

The Bar Ain’t Very High: Consider that in November, the consensus estimate was for a slight 7-cent loss … and JCP blew through that with an adjusted loss of 93 cents a share! The stock tanked about 9% on that day. Customers — and investors — were confused by pricing strategies, its shop concept and other strategic initiatives. So it won’t take a heck of a lot to provide a better showing this time around.

Why JCP Has Upside

Short Squeeze Potential: As we saw with Sears Holdings (NASDAQ:SHLD) at the beginning of last year, a fading brick-and-mortar giant doesn’t have to do much to scare off the short sellers and squeeze higher. Beset by negativity after store closure news and even bankruptcy talk, Sears crashed to $30 to start 2012 … but gapped up to almost $86 by spring. Shares have come back to the $50 range as of late, but swing traders who were there at the bottom got a heck of a payday. All it could take is one big headline — a sales surprise, a management shakeup, whatever — to send the short sellers running for the exits. As of mid-January, JCP was one of the five most-shorted stocks in the S&P 1500 with some 46% of its float held short.

Leaner Staffing: While it is unfortunate for those losing the jobs, the reality is that a struggling business like JCPenney needs to “right size” to stay competitive. And according to recent reports, as many as 1,000 more layoffs might be in the works. This comes after some 3,100 layoffs in the last 18 months or so — which will help prop up the bottom line in the short-term while the company looks to reinvent itself.

Return of Consumers … Eventually: After yet another disappointing holiday shopping season, the good news is JCP has picked a decent time to blow up its model and rejigger store strategies. After all, consumers will return eventually — and whether it’s later in 2013 or in 2014, the bottom line is that it’s better for Penney to change course now than to miss the opportunity when consumers begin opening their wallets again in earnest. Granted, that could be a few years out, but let’s face it … JCP isn’t exactly going to turn around in a hurry, either. So the timing might work.

Admittedly, you might be catching a falling knife here. There’s no guarantee that if JCPenney slips back to $18 that it won’t continue sliding back to $16 on continued sales trouble. And we haven’t even touched on e-commerce competition from the likes of Amazon (NASDAQ:AMZN) or changing consumer tastes — two very real threats to the entire JCP model.

But given the “risk-on” environment of late on Wall Street and the deep price declines in previous failures, it might be worth considering a turnaround play in JCP.

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Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, Jeff held a long position in Apple stock.

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