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ACCT600 MAFM CAPSTONE May 2013 Professor Patrick Berry Team C Samantha Ancell Angelica Guerrero Angelica Melton Jessica Rootz PPaPage
Transcript of files.transtutors.com€¦ · Web viewACCT600 MAFM CAPSTONE. May 2013. Professor Patrick Berry....
ACCT600 MAFM CAPSTONE
May 2013
Professor Patrick Berry
Team CSamantha Ancell Angelica GuerreroAngelica MeltonJessica RootzCordez Williams
June 23, 2013
PPaPage
Table of Contents1 EXECUTIVE SUMMARY..........................................................................................................................7
2 INDUSTRY OVERVIEW.........................................................................................................................11
2.1 Industry Snapshot........................................................................................................................11
3 ORGANIZATION AND STRUCTURE.......................................................................................................14
3.1 Belk, Inc........................................................................................................................................14
3.1.1 History...................................................................................................................................14
3.1.2 Organizational development.................................................................................................14
3.1.3 Marketing Strategies.............................................................................................................15
3.1.4 Growth and profitability........................................................................................................15
3.1.5 Acquisition Risks....................................................................................................................15
3.2 Kohl’s Corporation.......................................................................................................................16
3.2.1 History...................................................................................................................................16
3.2.2 Organizational Structure and Corporate Issues.....................................................................17
3.2.3 Executive Officer Overview...................................................................................................17
3.2.4 Product Development...........................................................................................................18
3.3 J.C. Penney Company, Inc............................................................................................................19
3.3.1 History...................................................................................................................................19
3.3.2 Organization..........................................................................................................................20
3.3.3 Product Development...........................................................................................................21
3.3.4 Legal Proceedings..................................................................................................................21
4 INDUSTRY LEADERS.............................................................................................................................23
4.1 Kohl’s............................................................................................................................................23
4.2 Macy’s Inc....................................................................................................................................23
4.3 Sears Holding Corporation...........................................................................................................24
4.4 J.C. Penney...................................................................................................................................25
4.5 Target Corporation.......................................................................................................................25
5 SWOT..................................................................................................................................................27
5.1 Strengths......................................................................................................................................27
5.1.1 Kohl’s.....................................................................................................................................27
5.1.2 J.C. Penney............................................................................................................................29
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5.2 Weaknesses.................................................................................................................................30
5.2.1 Kohl’s.....................................................................................................................................30
5.2.2 J.C. Penney............................................................................................................................31
5.3 Opportunities...............................................................................................................................33
5.3.1 Kohl’s.....................................................................................................................................33
5.3.2 J.C. Penney............................................................................................................................35
5.4 Threats.........................................................................................................................................37
5.4.1 Consumer Confidence...........................................................................................................37
5.4.2 Exhibit 5.4.2 - Trend in Self-Reported U.S. Average Daily Spending......................................38
5.4.3 Shopping Trends....................................................................................................................38
5.4.4 Government Regulations......................................................................................................39
5.4.5 Economic Conditions.............................................................................................................39
6 RISK ANALYSIS.....................................................................................................................................41
6.1 Reputational Risk.........................................................................................................................41
6.1.1 Managing Reputational Risk..................................................................................................42
6.2 Operational Risk...........................................................................................................................43
6.2.1 Exhibit 6.2.1: Sector Risk Radar.............................................................................................46
6.2.2 Managing Operational Risk...................................................................................................46
6.3 Procedural Risk.............................................................................................................................47
6.3.1 Managing Procedural Risks...................................................................................................49
6.4 Financial Risk................................................................................................................................50
6.4.1 Managing Financial Risk........................................................................................................52
6.5 Human Resource Risk...................................................................................................................54
6.5.1 Managing Human Resource Risk...........................................................................................56
7 Valuation- Kohl’s.................................................................................................................................58
7.1 Weighted Average Cost of Capital................................................................................................58
7.2 Sources of Debt............................................................................................................................58
7.3 Sources of Equity..........................................................................................................................60
8 VALUATION – J.C. PENNEY..................................................................................................................66
8.1 Book Value...................................................................................................................................66
8.2 Book Value Per Share...................................................................................................................66
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8.3 Market Value................................................................................................................................66
8.4 Intrinsic Valuation........................................................................................................................67
8.4.1 Forecasted Financial Statements..........................................................................................68
8.4.2 Exhibit 10.4.2: Forecasted Financial Statements for J.C. Penney..........................................68
8.4.3 Present Value of Operations.................................................................................................70
8.4.4 Exhibit 10.4.4: J.C. Penney Value of Operations...................................................................71
9 PERFORMANCE MEASUREMENTS.......................................................................................................72
9.1 Asset Utilization...........................................................................................................................72
9.1.1 Sales to Working Capital.......................................................................................................72
9.1.2 Days of Working Capital........................................................................................................73
9.1.3 Sales per Person Ratio...........................................................................................................73
9.1.4 Asset Utilization Table...........................................................................................................73
9.2 Operating Performance................................................................................................................74
9.2.1 Gross Profit Percentage.........................................................................................................74
9.2.2 Operating Profit Percentage..................................................................................................74
9.2.3 Net Profit Percentage............................................................................................................75
9.2.4 Operating Performance Table...............................................................................................75
9.3 Cash Flow Measurements............................................................................................................75
9.3.1 Cash Flow from Operations...................................................................................................75
9.3.2 Cash Flow Return on Assets..................................................................................................76
9.3.3 Cash to Working Capital Ratio...............................................................................................76
9.3.4 Cash Flow Measurements Table............................................................................................76
9.4 Solvency Measurements..............................................................................................................77
9.4.1 Times Interest Earned...........................................................................................................77
9.4.2 Debt to Total Assets..............................................................................................................77
9.4.3 Cash Debt Coverage Ratio.....................................................................................................77
9.4.4 Solvency Measurements Table..............................................................................................78
9.5 Liquidity Ratios.............................................................................................................................78
9.5.1 Net working capital...............................................................................................................78
9.5.2 Current ratio..........................................................................................................................79
9.5.3 Quick or acid test ratio..........................................................................................................79
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9.5.4 Liquidity Measurements Table..............................................................................................79
9.6 Activity Ratios...............................................................................................................................80
9.6.1 Inventory turnover ratio........................................................................................................80
9.6.2 Average age of inventory......................................................................................................80
9.6.3 Average collection period.....................................................................................................81
9.6.4 Activity Measurements Table................................................................................................81
9.7 Return on Investment Measurements.........................................................................................81
9.7.1 Return on Equity (ROE).........................................................................................................81
9.7.2 Dividend Payout Ratio...........................................................................................................82
9.7.3 Return on Assets (ROA).........................................................................................................82
9.7.4 Return on Investment Table..................................................................................................83
9.8 Market Performance Measurements...........................................................................................83
9.8.1 Sales to stock price ratio.......................................................................................................83
9.8.2 Price/earnings ratio (P/E)......................................................................................................84
9.8.3 Earnings per share.................................................................................................................84
9.8.4 Market Performance Measurements Table..........................................................................85
10 CONCLUSION AND RECOMMENDATIONS...........................................................................................86
10.1 Optimal Capital Structure..........................................................................................................86
10.2 How to Fund Acquisition............................................................................................................87
10.3 Growth Plan...............................................................................................................................89
11 WORKS CITED......................................................................................................................................90
12 APPENDIX............................................................................................................................................98
12.1 Appendix 1.................................................................................................................................98
12.1.1 Industry Overview Sales per square foot............................................................................98
12.1.2 Kohl’s Income Statements for the past 3 years...................................................................99
12.1.3 J.C. Penney’s Income Statements for the past 3 years......................................................100
12.1.4 Growth, Profitability, and Financial Rations for Kohl’s Corporation..................................101
12.1.5 Kohl’s Valuation and Industry comparison........................................................................102
12.1.6 Growth Profitability and Financial Ratios for J.C. Penney.................................................103
12.1.7 Distribution Centers for Kohl’s Corporation......................................................................105
12.1.8 “Nine-Box Merchandising Grid”........................................................................................106
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12.1.9 J.C. Penney WACC.............................................................................................................107
13 APPENDIX 2 FINANCIAL STATEMENTS...............................................................................................108
13.1 Kohl’s Income Statement.........................................................................................................108
13.2 Kohl’s Balance Sheet................................................................................................................110
13.3 Kohl’s Statement of Cash Flows...............................................................................................112
13.4 J.C. Penney Income Statement................................................................................................114
13.5 J.C. Penney Balance Sheet........................................................................................................116
13.6 J.C. Penney Statement of Cash Flows.......................................................................................117
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1 EXECUTIVE SUMMARY
The retail industry has seen many changes over the decades. Most of the changes have
been due to economic recessions and rocky consumer confidence in the past. The trend amongst
retailers in 2013 has been utilizing more technology solutions and customer feedback to drive the
direction of the retail industry. The National Retail Federation expects a 3.4% increase in retail
sales across the industry for 2013. Furthermore, they forecast a 9 to 12% increase in online retail
sales for 2013 (Brown & Grannis, 2013).
Belk was not chosen as either the parent or target company. The company has been
showing steady growth of the last 5 years; however, it is determined to only explore new
opportunities where the company is recognized and well known. This would limit expansion to
the three regional areas that the company has established. It would also mean that a new
acquisition by Belk would cause the closing of stores outside the target area if it were the parent
company. Another risk factor is the amount of debt that Belk has in variable rate debt. The
company currently holds $97.8 million in variable debt as well as $80 million in notional swap
rate that is fixed and set to expire in 2013.
Kohl’s was chosen as the parent company. To offer the widest possible variety of
products with price points to meet every family’s needs, Kohl’s employs the use of private,
national, and exclusive brands. In the beginning, Kohl’s department stores had a wide variety of
offerings. In today’s stores, Kohl’s has limited their product offerings to six areas including
clothing for women (31%), men (19%), and children (13%), accessories (10%), home (18%), and
footwear (9%) (Kohl's Corporation, 2013a).
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J.C. Penney was chosen as the target company. Though the company has reported
repeated losses in sales each quarter, J.C. Penney still saw an annual revenue run rate of $2.635
billion in the first quarter of 2013. J.C. Penney has a long history selling affordable clothing.
When first opened in 1902, the company catered to farmers and their families, selling blue jeans,
blue-collar work clothes, shoes, fabrics, and sewing needs. Since its opening, J.C. Penney has
established 1,104 department stores in 49 states and Puerto Rico as of February 2013.
Some of Kohl’s key competitors are Target, Macy’s and J.C. Penney. Due to recent
struggles, J.C. Penney has fallen behind in the list of industry frontrunners. Kohl’s achievements
have proved to be enough to push them past competitors like J.C. Penney over the years. Their
internet presence can be assisted with the addition of J.C. Penney’s internet marketing presence.
Recent shopping trends have shown that internet shopping is continuing to grow exponentially.
Kohl’s will potentially realize more financial gains with the merger along with an increased
market presence. Kohl’s customer satisfaction focus will point them in a direction to achieve
such gains. They will have to stay aware of future economic conditions and consumer confidence
to maintain their growing annual sales track.
One of the important steps of analyzing a potential acquisition is determining any risks
that may result. During our analysis we identified several risks that require management to plan
accordingly for including reputational, operational, procedural, financial, and human resource
risks. The acquisition of J.C. Penney should require the planning necessary to prevent a drop in
reputation for Kohl’s by implementing Kohl’s philosophies into the J.C. Penney model such as
customer service standards and Kohl’s Cash. Completing an overall analysis of both
organizations supply chain, minimizing overlap, and implementing systems to prevent
disruptions should prevent operational risks, such as supply chain disruptions.
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Both organizations have unfortunately faced breaches of PII from their systems and
Kohl’s will need to implement a corporate wide policy for internal controls and fraud checks to
prevent catastrophic losses on either side. The acquisition of J.C. Penney will require Kohl’s to
form a plan for the future of the organization to mitigate the overwhelming financial risk it could
face by taking on the failing organization. In addition to all other risks, Kohl’s will be required
to delicately balance the need to overhaul the human capital aspect of J.C. Penney with the need
to revitalize the retail store in order to redirect the pathway of J.C. Penney to a successful
member of the industry.
The valuation of Kohl’s and J.C. Penney is an important part of the merger process. In
order to determine if the merger is viable, we needed to determine the intrinsic valuation of the
Company. The steps involved many ratios and formulas including the weighted average cost of
capital for both Kohl’s and J.C. Penney. The weighted average is needed to determine how
much the company is paying for their use of capital. This resulted with a 6.94% for Kohl’s and
15.42% for J.C. Penney, which is more than double the cost for Kohl’s and thus, makes J.C.
Penney the weaker company.
In our evaluation, J.C. Penney’s intrinsic value equated to $5,337 million and resulted in
the net equity value of $2,469 million by reducing the value of debt of $2,868 million. It’s also
important to point out that we provided a forecasted financial statement for one year which is
also important in the process of mergers and that is to provide Kohl’s management with a sneak
peak of the prospective merger or the inherent risk. We used 2011 figures because J.C. Penney’s
2012 fiscal year end reflected a substantial net loss that we feel is an anomaly and will not occur
again.
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There are several ratios that a company can analyze in order to determine how successful
the company will be and whether or not it is a good investment. Some of the most important
ratios to take into consideration are the days of working capital ratio, the cash to working capital
ratio, the cash debt coverage ratio, the quick test ratio, the inventory turnover ratio, return on
assets and the earnings per share. When looking at the big picture of an investment it is
important to determine how important each category of these ratios are and what they tell
management and investors about the company. It is also important to gauge the priority that these
ratios should be considered since some ratios may show positive results while other may not.
Management also has the responsibility to determine if making reasonable changes among the
company and implementing new policies and procedures can change some of the negative ratios.
With the optimal capital structure for Kohl’s at 40% debt and 60% equity, it is in the best
interest of Kohl’s to finance the acquisition using existing treasury stock inventories rather than
long term debt. While Kohl’s has a higher than optimal amount of debt, the use of treasury stock
to finance the acquisition would bring the organization back in line with the best interests of the
shareholders in mind. The acquisition of J.C. Penney will benefit Kohl’s in a number of ways
including doubling their footprint across the United States, speeding up fulfillment abilities by
doubling distribution centers, and implementing some of J.C. Penney strategies that have proven
profitable in the past. J.C. Penney will benefit from the success Kohl’s has experienced in
customer service and marketing strategies. Overall, both organizations will mutually benefit
from the acquisition as long as it is adequately planned.
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2 INDUSTRY OVERVIEW
2.1 Industry Snapshot
The retail industry has gone through several changes in climate over the years. Many
retailers have begun to take on a great deal of online sales more than traditional brick and mortar
sales. The retail industry has seen many changes over the decades. Most of the changes have
been due to economic recessions and rocky consumer confidence in the past. Some retailers have
decided to no longer report monthly sales results such as Kohl’s, Macy’s and Nordstrom (Zacks
Equity Research, 2013). The trend amongst retailers in 2013 has been utilizing more technology
solutions and customer feedback to drive the direction of the retail industry. For example,
Macy’s saw a sales growth of 47.7% for their fourth quarter online sales in 2012 (Russell, 2012).
Retail giant JC Penny has begun to reevaluate its operations to create sales growth.
Management implemented new company logo, cost reduction and new pricing strategies to
enhance the company’s image and growth potential. As of 2012, JC Penny was ranked 153 on
the Fortune 500. Kohl’s was ranked 146 and Macy’s was ranked 110 on the Fortune 500 in 2012.
The retail industry reported more than 4.7 trillion in total sales for 2011. This was the largest
increase in sales since 1999 (Farfan, 2011).
The U.S. has more than 5 of the top retailers in the world; with Wal-Mart being the
largest retailer in the world. The industry is segmented into hard retailers and soft retailers. Hard
retailers are considered appliances, electronics and furniture for example. Soft retailers often sell
clothing and apparel (N.A., 2013a). Kohl’s, JC Penny and Belk all fall under soft retailers. Also
there are store retailers and non-store retailers. Store retailers have displays that attract customers
to make purchases on site. Retailers such as vending machines and e-commerce are labeled as
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non-store retailers. Many store retailers have crossed into both sides of retailing. Two-thirds of
the United States GDP comes from the retail industry (Brown & Grannis, 2013). The industry
was affected tremendously by the recession in 2007. The recession affected the industry for
nearly two years before beginning a recovery process. Many of the larger retailers are in the
process of recovering and reporting pre-recession sales. Furthermore, the National Retail
Federation expects a 3.4% increase in retail sales across the industry for 2013. They forecast a 9
to 12% increase in online retail sales for 2013 (Brown & Grannis, 2013).
This agrees with the trends that online retail is growing rapidly. The industry has seen a
great deal of their sales coming from the non-traditional method of sales. The retail online sales
grew 11% in the months of November and December. The retail store industry has 38 firms and
16.85% growth rate as of January 2013 (Damodaran, 2013). Consumer spending and economic
conditions affect the retail industry profitability. Consumer spending affected the industry during
the economic recession and drove many retailers’ profits down. This affected retailers and they
began to use creative ways to increase consumer spending. Consumer confidence has been down
over the years and this has affected the retail industry sector.
Also technology trends have affected the retail industry and retailers’ have used strategic
ways to utilize technology into their business. The National Retail Federation has stated that
“Stores spend $34.5 billion a year on all kinds of technology, from the cables and routers behind-
the-scenes, to in-store devices such as price checkers, self-service checkout stations and
electronic kiosks for customers” (Aversa, 2007). For example, retailers such as JC Penny have
begun to use the iPhone during checkout at the sales counter. Consumers use this as the new
signature pad when completing debit and credit sales. The retail industry has several regulations
depending upon the state that the retail store operates. At the moment nineteen states and two
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territories have regulations in place for unit pricing. Also eight states currently have mandatory
item pricing regulations. Some of the states included are New York, Connecticut, New
Hampshire and Massachusetts (Sefcik, 2013).
Analysts’ breakdown many retail stores performance by analyzing their inventory
turnover and sales per square feet. Many of the larger retail store chains such as Macys have a
large inventory turnover and a great deal of sales per square feet. Kohl’s as of 2012 had an
average of $190 per square feet in sales and JC Penny had an average of $155 per square feet in
sales (N.A., 2013a). Kohl’s had one of the best sales per square feet amongst their competitors.
Some of their competitors are Nordstrom, Macy’s, JC Penny, and Dillard’s. Dillard’s posted the
lowest amount of sales per square feet amongst the group of competitors.
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3 ORGANIZATION AND STRUCTURE
3.1 Belk, Inc.
3.1.1 History
Belk began in 1888 as a small store in Monroe, NC. William Henry Belk and his brother
Dr. John Belk founded it. The original name was “New York Racket” followed by “Belk
Brothers” and finally shortened to Belk. It has grown into one of the largest privately held
department stores. Belk started from the humble beginnings of a small loan and savings and a
couple of items taken in consignment. In 1908 the headquarters of this growing company were
moved to Charlotte, NC. It is known as a southern style for all members of the family, although
its focus has been women’s’ fashion. Its main product lines are composed of clothing, footwear,
bedding, housewares, and beauty products among others (Belk, 2013a).
3.1.2 Organizational development
Belk currently has 306 locations across the southern part of the United States. The largest
concentration of Belk stores is currently in the Atlanta metro area. And the westernmost location
is in Texas. Even though it became a public company, the business is still family-operated with
over 90% of the class A stock still held by the Belk family. Belk looks for opportunity to
continue a steady business. In 2005 they sold their private-label credit card to GE Money Bank.
Following this transaction they purchased 47 Proffitts and McRae’s department stores and
converted 39 of them to their name brand. Furthermore, the following year they purchased 38
Parisian stores and converted most of them as well. Although it has continued to expand its
stores, the department chain has opted to maintain limited online merchandising and does not
offer all of its products online. Belk operates in three regional divisions that are headed by a
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division chair followed by a director of stores. The division offices are in charge of
implementing initiatives to each individual store including support for management and
employees, and maintenance and operations (Belk, 2013b).
3.1.3 Marketing Strategies
The chain embarked on a $70 million marketing campaign with the launch of their new
logo and slogan in 2010. As part of their product development strategy, Belk has implemented
the first phase of Project IMPACT. This consists of restructuring on merchandising,
organizational planning and development of more sophisticated planning processes and tool. In
order to begin this initiative additional planners were hired and teams implemented. These teams
work together to implement stronger merchandise assortments that are tailored to the key players
of Belk’s target market. Also Project SMART was implemented to upgrade the systems and
technological structure of the company. This project has allowed the team to develop and
execute more advanced merchandising practices in the areas of purchasing, planning,
replenishment, pricing and promotion and financial planning (Belk, 2013b).
3.1.4 Growth and profitability
The company has been showing steady growth of the last 5 years. There was an increase
in total revenue of 5.3% from 2011 to 2012 and an increase of store sales of 5.5%. Belk has
focused its growth strategy on remodeling and expanding their current stores as oppose to
acquiring new ones in new markets. It is determined to only explore new opportunities where the
company is recognized and well known. This would limit expansion to the three regional areas
that the company has established. It would also mean that a new acquisition by Belk would
cause the closing of stores outside the target area if it were the parent company.
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3.1.5 Acquisition Risks
As an acquisition, the area would also limit the expansion of the department store into
other territories. Another risk factor is the amount of debt that Belk has in variable rate debt. The
company currently holds 97.8 million in variable debt as well as 80 million in notional swap rate
that is fixed and set to expire in 2013. Belk is also not hesitant to close stores. In 2012 the
company had 3.5 million net changes for exit costs due to a single store closing as well as 1.3
million charges. Due to the above limitations our group did not chose Belk for either a parent
company or an acquisition venture (Belk, 2013b).
3.2 Kohl’s Corporation
3.2.1 History
“Super” stores are becoming the big trend in the 21st century shopping experience for the
average consumer. One stop shopping where consumers can purchase their groceries, furniture,
and auto care needs all in one spot. Kohl’s Corporation has done just the opposite of the intense
movement towards the all in one shopping experience. Mr. Max Kohl established his brand as
the “largest supermarket chain in the Milwaukee [Wisconsin] area” with his Kohl’s grocery
stores prior to opening his first Kohl’s department store in 1962 (Kohl's Corporation, 2013d).
In the late 70s and into the early 80s, Kohl’s food and department stores were bought out
by BATUS, Inc. and the grocery side of the business was sold to an outside party (Kohl's
Corporation, 2013d). In 1986, Kohl’s Corporation was formed when a subset of investors
purchased the company from BATUS, Inc. (Kohl's Corporation, 2013d). In 1992, Kohl’s
Corporation made its initial public offering with over 11 million shares (Kohl's Corporation,
2013d). Since that time the stock has split multiple times vastly increasing the shareholder’s
wealth. As of the current 2012 SEC 10-K filing, Kohl’s Corporation does not have any material
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legal proceedings that would greatly affect the shareholders of the company (Kohl's Corporation,
2013a).
3.2.2 Organizational Structure and Corporate Issues
While the corporate headquarters are still based in the suburbs of Milwaukee, Wisconsin
(specifically Menomonee Falls), Kohl’s has dramatically expanded their presence across the
nation. As of end of their 2012 fiscal year, Kohl’s Corporation had 1,146 stores across the
country with a presence in every state except Hawaii (Kohl's Corporation, 2013a). In addition
to their physical stores they have several distribution centers strategically located across the
country to service all 1,146 stores and their blossoming online business. The distribution
centers and their areas of coverage are included in 12.1.7 of the Appendix. While they have a
tremendous presence in the state of California with 128 stores, the states with the least amount
of physical presence is in Vermont and Alaska with one store each (Kohl's Corporation, 2013a).
In support of the numerous stores across the country, Kohl’s has a tremendous social
awareness initiative called “Kohl’s Cares” to give back to the communities for which they
service (Kohl's Corporation, 2013d). Not only do they provide quality products for various price
points, they express and act on concern for the health and well being of women, children, and the
environment. Kohl’s Cares has had a tremendous impact on the community by raising over $200
million in support for Kohl’s Kids and $57 million in support of local community service (Kohl's
Corporation, 2013d).
3.2.3 Executive Officer Overview
The executive management of the Kohl’s Corporation has a tremendous amount of
knowledge and experience in the retail industry. Each member of the executive management has
at least 20-30 years of retail experience. The following are members of Kohl’s Corporation
executive management team (Kohl's Corporation, 2013a):
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Kevin Mansell, Chairman, CEO Don Brennan, Chief Merchandising Officer John Worthington, Chief Administrative Officer Kenneth Bonning, Senior Executive VP Peggy Eskenasi, Senior Executive VP Wesley S. McDonald, Senior Executive VP and CFO Richard D. Schepp, Senior Executive VP, General Counsel, and Secretary
Mr. Mansell has been proudly serving Kohl’s Corporation for over a quarter of a century.
He began as a low level manager and has gradually worked his way through the ranks of
management to his currently held position of Chairman and CEO. According to his biography
on the Kohl’s Corporation website, Mr. Mansell started his career with Kohl’s Corporation in
1982 and was promoted to divisional merchandising manager in 1987 (Kohl's Corporation,
2013c). Over the following decade, he was selected for Senior Executive VP of Merchandising
and Marketing and then promoted to President in 1999 (Kohl's Corporation, 2013c). His current
appointments of CEO and Chairman of the Board came in 2008 and 2009, respectively (Kohl's
Corporation, 2013c).
Mr. Brennan and Mr. Worthington have not been with Kohl’s Corporation as long as Mr.
Mansell; however, they both have a tremendous amount of experience in the retail industry
through other department store/corporations. Mr. Brennan started his career with Kohl’s
Corporation in 2001 and has held various management positions throughout his 12 years with the
company (Kohl's Corporation, 2013c). Mr. Worthington started his career with Kohl’s
Corporation in 1993 and has moved up from district level management positions to executive
management in his 20 years with the company (Kohl's Corporation, 2013c).
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3.2.4 Product Development
Since the late 80s, Kohl’s Corporation has been gradually crafting their business into a
profitable art form. Over the last 2.5 decades Kohl’s department stores have refined the product
offerings and removed the excess products that were weighing the operations of the corporation
down. In the beginning, Kohl’s department stores had a wide variety of offerings. In today’s
stores, Kohl’s has limited their product offerings to six areas including clothing for women
(31%), men (19%), and children (13%), accessories (10%), home (18%), and footwear (9%)
(Kohl's Corporation, 2013a).
To offer the widest possible variety of products with price points to meet every family’s
needs, Kohl’s employs the use of private, national, and exclusive brands. The private label
brands provide Kohl’s with the opportunity to compare with national and exclusive brands on the
price point aspect while earning a higher profit off of the individual sale. Kohl’s attracts certain
consumers by carrying exclusive brands such as Jennifer Lopez, Rock & Republic, and Food
Network (Kohl's Corporation, 2013d). Kohl’s has been able to identify three different lifestyles
and three different price points for its consumer base for which they have constructed “Nine-Box
Merchandising Grid” as seen in 12.1.8 of the Appendix (Kohl's Corporation, 2013d).
3.3 J.C. Penney Company, Inc.
As the target company, J.C. Penney can bring a lot to the table. The recent revolving
door of Chief Executive Officers leaves the company ripe for a new path. Though the company
has had known issues, reporting repeated losses in sales each quarter, J.C. Penney still saw an
annual revenue run rate of $2.635 billion in the first quarter of 2013. The beleaguered company
would do well to come to an agreement with Kohl’s where there exists some synergy, and where
a known method of success has been achieved.
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3.3.1 History
J.C. Penney Company (JCP) was founded in 1902 by James Cash Penney. Incorporated
in 1924 as JCP, and then again in 2002 as J.C. Penney Company Inc., when the holding company
structure was implemented. J.C. Penney has a long history selling affordable clothing. When
first opened in 1902, the company catered to farmers and their families, selling blue jeans, blue-
collar work clothes, shoes, fabrics, and sewing needs. Mr. Penney originally referred to his
stores as the Golden Rule, because he wished to treat customers the way he himself would want
to be treated (J.C. Penney, 2013a).
3.3.2 Organization
As of April 2013, top Senior Executives at J.C. Penney consists of: Mike Ullman,
recently reinstated Chief Operating Officer; Kenneth Hannah, Executive Vice President and
Chief Financial Officer; Janet Dhillon, Executive Vice President, General Counsel and Secretary,
and Mark Sweeney, Senior Vice President and Controller.
J.C. Penney has had several CEOs in the past few years. In June 2011, Ron Johnson
replaced retiring CEO Mike Ullman. Johnson, a former Senior Vice President of Apple, Inc. had
planned on bringing a newer, hipper vibe to J.C. Penney. However, after a nearly $170 million
loss over the course of Johnson’s tenure, the board of directors could no longer allow the
performance to continue and officially fired him in April 2013. They reinstated former CEO
Mike Ullman, who now has a long battle ahead of him to try to turn the company around.
J.C. Penney operates within: Alabama, Alaska, Arizona, Arkansas, California, Colorado,
Connecticut, Delaware, Florida, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky,
Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri,
Montana, Nebraska, Nevada, New Hampshire, New Jersey, New Mexico, New York, North
Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina,
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South Dakota, Tennessee, Texas, Utah, Vermont, Virginia, Washington, West Virginia,
Wisconsin, Wyoming, and Puerto Rico (J.C. Penney, 2013b).
The only state J.C. Penney is not currently conducting business in is Hawaii. There were
several stores in the island state in the 1960s; however, all were closed in 2003 due to the high
cost of maintaining operations combined with low profits (Fujimori, 2002).
3.3.3 Product Development
In the 1960s J.C. Penney expanded outside of clothing and fabrics and started selling
appliances, sporting goods, garden merchandise, restaurants, and auto parts. The company also
expanded into services like portrait studios and auto centers. In 1963 J.C. Penney issued its first
catalog distributed by the Milwaukee Catalog distribution center. In 1969, the company acquired
Thrift Drug (rebranded Eckerd in 1997) and Supermarkets Interstate, thus starting its ventures
into drugstores, pharmaceuticals, and as a food retailer. Its foray into the auto industry was short
lived however; in 1983 J.C. Penney phased out its hardware and auto departments and sold its
auto repair shops to Firestone (Wikipedia, 2013).
In 1984 J.C. Penney acquired the First National Bank and began issuing its own
MasterCard and Visa cards. In 1993 J.C. Penney became the largest catalog retailer in the
United States when Sears closed its catalog business. In 2004 J.C. Penney exited the drug store
and pharmaceutical division with the sale of Eckerd. In 2007 J.C. Penney launched its own
lingerie label, Ambrielle, and partnered with Sephora, a cosmetics company, to set up “stores-
within-a-store” inside some J.C. Penney locations. The catalog business remained strong until
January 2011, when J.C. Penney announced it would be phasing out of catalogs in favor of
furthering its online business (Wikipedia, 2013). Since its opening, J.C. Penney has established
1,104 department stores in 49 states and Puerto Rico as of February 2013.
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3.3.4 Legal Proceedings.
J.C. Penney is involved in a couple of current legal proceedings. A bond litigation suit
claims that J.C. Penney filed to prevent debt holders from claiming that it defaulted on a bond.
J.C. Penney had received a letter from Brown Rudnick on February 4, 2013 on behalf of bond
holders, stating that J.C. Penney had breached a covenant of the a bond indenture agreement by
granting lien on its inventory. CFO, Ken Hannah gave an official statement that the default was
invalid and without merit, and that J.C. Penney was filing lawsuit to protect nearly $3 billion of
debt from being due within months of the letter (Hals, 2013). On March 18, 2013 the courts
ordered a hearing for summary judgment; immediately following the hearing J.C. Penney
received a withdrawal of the notice of default from the Bondholders’ Counsel (J.C. Penney,
2013b).
In addition, there is a Macy’s litigation that concerns an ongoing and escalating battle
between J.C. Penney and Macy’s over the rights to sell Martha Stewart merchandise. On August
16, 2012, Macy’s intensified the battle by filing a lawsuit that accused J.C. Penney of interfering
with its contract with Martha Stewart Living Omnimedia, Inc. As of April 2013, there has been
no resolution and both companies have been ordered into mediation during a month long recess.
Though J.C. Penney is not sure what the ultimate outcome will be, the company does not feel
that it will have an adverse material effect on their operations, financial position, liquidity, or
capital resources (J.C. Penney, 2013b).
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4 INDUSTRY LEADERS
This section will focus on Kohl’s key competitors in the multiline retail industry.
According to Forbes, the key competitors are Macy’s, Sears Holding Corporation, and J.C.
Penney; however the main competitor is Target. (Forbes, 2012). We’ve chosen these companies
because of their well-known status in the community and their rankings in the industry.
4.1 Kohl’s
The financial data obtained from Morningstar and reflected in the charts in the appendix
shows that in 2012 the revenue was $18 million with operating income of $2,158 million and net
income of $1,167 million. Even with the economic crisis, according to the charts in the
appendix, Kohl’s has steadily achieved small but persistent growth in revenue and net income
even though in 2009 and 2010 there was a minor decrease, in 2011 the Company started
increasing again (Morningstar, 2013c). Kohl's overcame J.C. Penney, which is significant since
the two chains are considered to be in direct competition for the same customer base.
4.2 Macy’s Inc.
Macy’s, Inc. has not always been known as Macy’s, Inc. Up until June of 2007 it was
known as Federated Department Stores, Inc. (Macy’s, Inc., 2013a). In 1929, a group of 4
department stores banded together to form Federated Department Stores, Inc.: Abraham & Straus
of Brooklyn, Filene’s of Boston, F&R Lazarus & Co. of Columbus, OH, and Bloomingdale’s of
New York (Macy’s Inc., 2013a). While all 4 department stores kept their individual names and
appearances, they combined their financial aspects to become a solid competitor during World
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War II and the Great Depression (Macy’s, Inc., 2013a). Federated Department Stores, Inc.
acquired Macy’s in 1994 and Broadway Stores in 1995 (Macy’s, Inc. 2013a).
Macy’s operate under two different names for their storefronts: Macy’s and
Bloomingdales with $27.7 billion in sales in fiscal year 2012 (Macy’s, Inc., 2013b). They have
over 840 stores between the two brands that span across “45 states, the District of Columbia,
Guam and Puerto Rico” (Macy’s, Inc., 2013b). In addition to their standard stores, Macy’s also
has outlet and website sales. They maintain 12 Bloomingdales outlet stores spread out amongst
9 states with Florida have 3 (Macy’s Inc., 2013b). Macy’s also has a wide presence on the
internet with both storefronts having respective websites for access to previously inaccessible
areas of the U.S. and around the globe (Macy’s, Inc., 2013b).
4.3 Sears Holding Corporation
Sears Roebuck & Co. and Kmart Holding Corporation merged in 2005 when Sears
Holding Corporation was formed. We all recognize the name Sears and Kmart; however they
are subsidiaries of the Sears Holding Corporation. According to the Sears Holding website, it “is
a leading integrated retailer with more than 2,500 full-line and specialty retail stores in the
United States and Canada. Sears Holdings is the leading home appliance retailer as well as a
leader in tools, lawn and garden, fitness equipment and automotive repair and maintenance
(Sears Holding Company, n.d.).
The retail industry is very competitive and throughout the long rich history of Sears, it
has flourished, emerged from Bankruptcy and now in 2012, the “Adjusted EBITDA of $429
million for the fourth quarter of 2012 and $626 million for the year, which were both in line with
our guidance provided on January 7, 2013. Adjusted EBITDA for the prior year fourth quarter
and year were $351 million and $277 million, respectively; Gross margin rate increased 130
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basis points for the fourth quarter of 2012 and 90 basis points for the year from the comparable
prior year periods; Sears Domestic's comparable store sales improved 0.8% in the fourth quarter
of 2012 and declined 1.4% for the year. Kmart's comparable store sales declined 3.7% in the
fourth quarter and for the year. Sears Canada's comparable store sales declined 3.8% in the
fourth quarter and 5.6% for the year (Sears Holding Company, n.d.).
4.4 J.C. Penney
In 1902 JC Penny opened as a dry goods store and has emerged as one of the leading
retailers in its early years having more than 2000 chains. 2012 has not been kind to the retailer
with the hiring of Ron Johnson; the Company has suffered, according to a story on Yahoo,
J.C. Penney’s dwindling, aging customer base left in droves. Sales were down a jaw- dropping 32% in the 4th quarter of 2012; an almost impossible feat for a company like J.C. Penney. The company was boring but not widely feared to be heading for a financial meltdown as recently as 2011. Now it’s pure excitement but not of the right kind (Macke, 2013).
4.5 Target Corporation
According to Forbes, Target is Kohl’s main competitor in the retail industry (2012).
Target started as a dry goods store in Dayton, Ohio in 1902. In 1967 the Company expanded to
become a national retailer and the following year it created the now famous logo of the bull’s-
eye. The Target store hit a major milestone when it became the #1 revenue producer of the
Dayton-Hudson Corporation and the following year the Company achieved an organizational
milestone by reaching $1 billion in sales. Throughout the years the Company expanded
nationally by opening stores and purchasing other retailers like Marshall Fields and Mervyns,
however they were later sold. In the year 2000, the Dayton-Hudson Corporation changed its
name to the Target Corporation to better reflect its core business. Target reached a major
milestone in 2005 by exceeding $50 billion in annual sales.
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The Company has grown even through the economic downturn and has emerged as a top
industry leader in the retail business. According to Morningstar, in 2012, the Company was very
close to reaching $70 million in revenue with 30% gross profit and $3 million in net income
(Morningstar, 2013b).
The aforementioned retailers have been innovative to maintain a profit especially in the
last few years with the economic downturn. According to SAS.com:
Throughout 2012, retailers will continue to adapt and adjust their brands and operations to fit with different cultures. Through store openings and brand expansion, US retailers are opening their arms to international shoppers like never before. Domestic and international expansion was another strategic initiative for retailers last year, as one-quarter of respondents in our Retail Horizons report said global expansion would be a major focus for their company (Shay, 2012).
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5 SWOT
5.1 Strengths
5.1.1 Kohl’s
Customer Satisfaction
Kohl’s builds its brand out of a commitment to family, good values and national brands.
The stores carry a variety of items to satisfy the needs of every shopper. From clothing to
accessories to small electronics and housewares, Kohl’s strives to make it an easy one-stop shop
for the entire family. They are an innovative company that is currently committed to developing
the convenience of shopping by expanding their online selection and making it simple to shop.
Part of this initiative is the layout of their stores, which includes centralized checkout aisles and a
racetrack style layout that circles the entire store (Kohl’s Corporation, 2013b).
Quality Merchandise and Competitive Edge
Kohl’s is committed to offering quality merchandise at a great price. As a company, their
marketing strategy focuses on setting a brand standard. They remove products that are not
profitable and offer a wide variety. They limit their product selection to six key areas. These
areas include men’s, women’s, and children’s clothing as well as accessories, housewares and
footwear. Kohl’s focuses on using national, private and exclusive brands to attract their target
clientele. By doing this, it provides the buyer with the option of obtaining the desired product at
a variety of prices to fit every budget. The exclusive brands like Jennifer Lopez, Mark Anthony,
and Rock & Republic, attract the consumer that likes to have a certain standard in their fashion.
The private brand gives Kohl’s a competitive edge. The consumer can compare prices and value
between the three options. If the consumer chooses the private brand it gives the company a great
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advantage while it earns a higher profit due to the price point of the items sold. The variety is
one of the key strengths of this company. The consumer is free to choose one of the three key
price points to fit their budget and lifestyles. (Kohl's Corporation, 2013d).
Store Expansion
Another notable strength of this company is their management team and their expansion
of stores. Kohl’s currently has over 1,100 nationwide and, with the exception of Hawaii, it does
not limit its expansion to a certain geographical area. This gives this company a tremendous
marketing advantages since they are able to develop clientele across the nation and online.
Furthermore, the locations of their distribution centers nationwide make the products available in
a timely manner to all their stores and their online customers (Kohl's Corporation, 2013d).
Kohl’s executive management team is composed of members with more than 20 years of
experience. The current CEO, Kevin Mansell, has been a part of the Kohl’s family for over
twenty-five years and worked his way up from lower management. This allows him to have a
perspective and understanding of the company that could otherwise be overlooked by someone
new to the industry.
Social Responsibility
Another important strength of this company is the reputation it holds within the
communities it operates. One of their initiatives is “Kohl’s Cares.” This program supports a
variety of causes throughout communities in the nation, including kid’s health, breast cancer
awareness, and education among others. Kohl’s Cares merchandise gives 100% of the profit to
support the fight against breast cancer, while the scholarship rewards students with outstanding
volunteer service. Another part of this program sponsors U.S. Youth Soccer and partners with
local hospitals to educate kids about the prevention of childhood obesity and injuries (Kohl's
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Corporation, 2013e). Furthermore, in 2009 it was recognized by Newsweek magazine as 18th
out of 500 of the largest corporations and 1st in the industry in their environmental track record
by having the largest solar power program of any retailer globally (Kohl’s Corporation, 2013b).
5.1.2 J.C. Penney
Affordable Clothing
J.C. Penney is well known for affordable clothing. Their targeted clientele at the time of
inception was farmers and their families. Their clothing was specially crafted to attract this
consumer and consisted mostly of work clothes, fabrics and sewing supplies. It slowly started
expanding to hit many other areas of interest for consumers including appliances, lawn and
garden, portrait studios and sporting goods among others. It currently has over 1,100 stores
across all fifty states as well as Puerto Rico.
Diversification
J.C. Penney has a diversity of departments that are leased within its stores in order to
attract clientele and maximize profits. These include Sephora, optical centers and portrait studios
among others. They strive to enhance the consumer’s shopping experience by providing these
value added services in their department stores. J.C. Penney has private and national brands that
are competitive. Among their brands is “American Living” developed by Ralph Lauren, this was
the largest private brand launch performed by the company. The brands target men’s, women’s,
children’s and baby clothing. They also launched a home collection named “Linden Street” that
is exclusively sold by J.C. Penney. (J.C. Penney, 2013c)
Online Expansion
J.C. Penney is currently renovating and remodeling stores and expanding its online
shopping availability and experience. Their online store has become one of the largest apparel
and home furnishing retails sites serving over 30 countries around the world. J.C. Penney has
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about 2,500 suppliers and does not depend on any of them exclusively. (J.C. Penney, 2013b) It
also reached an agreement to offer full service cafes in its stores which added value to the
shopping experience. J.C. Penney has stated aggressive marketing strategies and inventory
management. It plans to incorporate “mini-Martha Stewart shops” during 2013 and has also
begun a new pricing method, which uses sale prices as every day prices. They have the
marketing initiatives including: “Monthly Value” and “Best Price”. Ellen DeGeneres has become
the spokesperson for the company” (J.C. Penney, 2013c).
5.2 Weaknesses
5.2.1 Kohl’s
Lack of Internet Presence
Kohl’s has several weaknesses that can be rectified with the acquisition of J.C. Penney’s.
There is a lack of internet presence, which greatly hinders sales. Internet presence is something
J.C. Penney has been focusing much attention on and would provide a needed synergy to Kohl’s
lacking in this area. Though J.C. Penney declined to publically report their 2012 4th quarter
internet sales, their history of climbing Internet Retailer’s top 500 list to number 20 in 2011
shows that they were marketing their internet presence well. Whereas Kohl’s ranked at No. 28 in
2012, which is not a bad spot out of 500, but we feel this could climb even higher with a stronger
internet presence (Woodard, 2013).
Internal Oversight and Impartiality
Another weakness that Kohl’s possesses is a concern with internal oversight among the
company’s board. Six directors are long tenured with over 10 years of service, comprising of
four board members who have served for about 25 years. It may be difficult for long tenured
members to act independently as they can often form relationships that may compromise their
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impartiality and consequently impede their ability to give effective oversight. (Rallis, 2012). An
influx of new board members from J.C. Penney would help correct this situation, though it would
mean a loss of some members from both companies.
Ineffective Compensation
In addition, executive officers’ annual bonuses are built on a single financial performance
measure of annual net income. To inhibit executives from being tempted to rig results, and to
ensure that they do not damage one goal while trying to achieve another, it is better if bonuses
are based off of a mix of performance metrics. Additionally, market-priced stock options that
vest based on timeframes are long-term incentives for named executive officers. To be effective,
equity rewards established for long-term incentives should contain performance-vesting features,
not features based solely on timeframes. Also, executive officers are entitled to performance-
vesting restricted stock rewards; however, the rewards are dependent on Kohl’s merely
exceeding its peer performance index in either 2011 or 2012. “This means not only that
executives may be rewarded even if the company underperforms or severely underperforms
peers in one of two years, but annual measuring periods are contrary to correctly designed long-
term awards” (Rallis, 2012, para 9). J.C. Penney seems to have a similar structure for bonuses
and awards, so this system weakness will have to be reviewed for improvement among both
companies.
5.2.2 J.C. Penney
Decline in Sales
J. C. Penney’s number one weakness is the drastic decline in comparable store sales for
2012. On the company’s 2012 SEC10-K report, J. C. Penney reported a decline of 25.2% in
stores open for one year or more (J.C. Penney, 2013b). A number of factors contributed to a
decline in the store sales and can be reasonably expected; however, J. C. Penney lost one quarter
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of their sales in one year. The double-digit decline is a slippery slope for the company to fall
onto and will be fighting an uphill battle to overcome.
Market Share
As a result of the double-digit decline in comparable store sales, the stock price has had
an extreme decline in its stock price and return on investment for shareholders. On May 23,
2008, the J. C. Penney stock price closed on the NASDAQ for $39.93 per share while 5 years
later the stock closed for $18.98 per share (NASDAQ, 2013). The 52.4% drop in stock price
represents investors’ lack of confidence in J. C. Penney’s ability to turn their operations into a
profitable organization that it has been since 1902 (J. C. Penney, 2013b). As presented in
Appendix, J. C. Penney’s return on investment is struggling compared with S&P 500 Stock
Index and S&P 500 Retail Index (J. C. Penney, 2013b).
Legal Issues
Over the last couple of years, J. C. Penney has been party to a handful of legal
proceedings that could negatively affect its operations in the future. Most recently, they were
part of a lawsuit filed by a portion of their bondholders that claimed J. C. Penney violated certain
covenants of the bond agreements (J. C. Penney, 2013b). While the plaintiff in the legal
proceedings withdrew their complaint, the potential for future proceedings is evident. With
$2.868 billion in long-term debt via indentures, if the company were to be found in violation,
“holders of a certain percentage of such debt instruments may declare such obligations
immediately due and payable” (J. C. Penney, 2013b). If the company were forced to repay a
portion of its bonds, the financial stability of the organization would be in jeopardy.
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Unfavorable Credit Rating
A 4th and 5th weakness of J. C. Penney relates back to their ability to finance the
operations in an economical manner. As presented in the Appendix, J. C. Penney is trending a
mediocre to unfavorable credit rating among the top 3 rating companies. With less than ideal
credit ratings, J. C. Penney will be less likely to obtain financing at in the amounts they need and
at the interest rates sustainable by the corporation. The lack of financing or increase in interest
rates could drastically affect J. C. Penney’s ability to operate in the future.
Overextended
J. C. Penney’s existing credit line was reissued multiple times over the last two years
with increases to the maximum allowed amount each time and is secured by their accounts
receivables and inventory (J. C. Penney, 2013b). The company is walking a line balancing its
needs for capital to fund operations and its potential for immediate repayment of the credit
document. The $1.850 million credit document has been able to fund J. C. Penney’s operations
and strategies for turning the company around (J. C. Penney, 2013b); however, if the value of its
collateral is impaired in any way, the company would be open to a financial weakness that it may
not be able to overcome.
5.3 Opportunities
5.3.1 Kohl’s
Financial Gain
With Kohl’s acquiring J.C. Penney, there are several opportunities that may be fruitful
with this new business venture. Creating synergy and financial gain are important components in
any acquisition. J.C. Penney has a long and rich history with the public and until the last couple
of years it’s had its share of troubles, however with that being said, this creates an opportunity
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for Kohl’s to acquire J.C. Penney for the same reasons. While J.C. Penney’s market share has
been decreasing, this will benefit Kohl’s by improving their negotiation power. This puts Kohl’s
in a strong cash position while J.C. Penney has liquidity issues and a disadvantage of refusing an
offer.
Tax Benefits
Additionally with the acquisition of J.C. Penney, there may be potential to take advantage
of net operating losses generated in 2012 from J.C. Penney. The tax treatment would depend on
the type of acquisition or merger and potential to generate tax benefits on the side of Kohl’s.
The tax benefit would be tremendous opportunity and reduce the income tax debt. Any and all
consideration should be provided towards minimizing corporate tax, by using the net operating
losses, credits and/or additional depreciation from the acquiring company.
Dominance Market Share
While Kohl’s and J.C. Penney complement each other, public brand perception is at an
all time low for J.C. Penney, however this can be turned around and the public can gain
confidence with Kohl’s acquiring J.C. Penney and create a potential turnaround situation. Old
customers can come back while still keeping the new customers. According to a Forbes article
“Their old customers…feel unwelcome. But the people…, who they hope become their new
customers, are so far just lukewarm. They kicked the old customers out before making sure new
customers would arrive” (Marzilli, 2013). This could possibly create dominance over the market
share by combining complementary businesses (Frost & Sullivan, 2013).
Social Media
Another opportunity is the value of how well J.C. Penney is holding strong on social
media. According to an industry study through Didgiday “Overall, JCP is winning in social
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media. Although, the numbers would say otherwise, from a social media standpoint, JCP’s social
strategy follows all of the best practices for engagement. Its posts are well thought out and do a
good job of delighting consumers and addressing their needs. Both experiences are user friendly”
(Abramovich, 2012). Kohl’s could learn how J.C. Penney is standing strong on the social media
sites and thus grow both brands as well as create positive feedback for both companies. This will
not only eliminate the competition and bring two competitors as one.
5.3.2 J.C. Penney
Expand and Rebuild
As with any S.W.O.T. analysis, opportunities are always a brighter side of the analysis
and J. C. Penney is no different. While they are currently trying to rebound from a dramatic
decline in comparable store sales in 2012, there are many opportunities for J. C. Penney to
succeed in the future. The first and probably the most profitable opportunity for J. C. Penney is
expanding and rebuilding their private label brand, an area that Kohl’s will be able to help
rebuild. Private label brands yield the most profit for their respective company. J. C. Penney has
a very strong history of private label brands, but is looking to move back in that direction.
Analysts believe J. C. Penney will move to have 50% of their merchandise private label brands
such as Worthington and Arizona Jeans (Loeb, 2013). Increasing the private label brand
percentage in the overall merchandise for the stores will produce greater profit margins for the
bottom line of the organization.
Return of Old Customer Base
Over the past couple of years, J. C. Penney has left behind a large chunk of its customer
base. They moved away from sales, coupons, and promotions thereby removing the incentive
for customers to shop at their beloved retailer. Recently, the CEO had mentioned that the
company would be moving back towards the historical pricing system to include “promotions 26
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times a year, often around holidays like Mother’s Day” (Clifford, 2013). The old customer base
has been surveyed and more than 50% of the population surveyed said, “they would return if the
company stocked its old merchandise and used its old pricing mechanisms” (Clifford, 2013). If
the company were able to build that customer base back, the organization would reap the benefits
of a loyal fan base previously cast to the side.
Promotions
The introductions of a similar mechanism offered by Kohl’s would also prove to be a
fantastic and untouched opportunity by J. C. Penney. One of the promotional tools Kohl’s uses
is Kohl’s Cash to draw customers into their stores during certain periods of time. If J. C. Penney
were able to introduce a similar promotional mechanism in their own stores, the additional
incentive for customers to shop would prove to be profitable endeavor for the organization. Gift
card logic transfers to potential for JCP Bucks. According to a study completed by First Data,
“two-thirds of consumers who received a gift card spent more than the card’s value, bringing in
additional revenue for merchants” which averaged $20.79 in 2012 (First Data, 2012). JCP Bucks
could be a tremendously profitable opportunity for the organization.
Higher End Customer
As of the 2012 SEC filing for J. C. Penney, they only had 386 Sephora stores within the
1,104 department stores (J. C. Penney, 2013b). The Sephora in J.C. Penney stores lure the
higher income customers into the store with their brand name beauty care products. The higher
income customers have to physically walk through the J. C. Penney store to get to the Sephora
store. With only a 34.9% coverage rate for Sephora stores within J. C. Penney stores across the
nation, the company could greatly benefit from expanding that subsection. Greater saturation of
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Sephora stores would bring a wider base of customers into the store for associates to close more
sales on higher profit items outside of Sephora.
5.4 Threats
Kohl’s and JC Penny have several elements that can be considered to be threats to them
and their entire industry. Threats are important for organizations to keep in mind. Some threats
for the retail industry to consider are consumer confidence, shopping trends, government
regulations and economic conditions.
5.4.1 Consumer Confidence
According to the New York Times, consumer spending has increased “2.4 percent in
2010, 1.8 percent in 2011 and 2.2 percent in 2012” (Huh, 2013). Sales at retail stores dropped in
March and it was the most in the past nine months. The growth in consumer spending has been
slow since the recession ended in 2009 (Huh, 2013). Personal income for many Americans has
been affected across the board due to increases in Social Security and increases in gas prices.
Consumer spending rose 0.7 percent in February of 2013 (Huh, 2013). U.S. Consumer spending
increased to an average of $89 daily in March. This was up from an average of $83 per day in
February. Higher income groups, which are considered $90,000+/year, have increased spending
greatly since the recession began in 2008. They have increased $56 per day in monthly spending
from 2008 to 2013. Lower income groups have only increased $1 per day spending average since
2008 (Jacobe, 2013). Consumer confidence is very important for the retail industry. This is
essential for the industry and drives growth for Kohl’s and J.C. Penney. As can be seen below,
consumer confidence has grown since 2008 and this has led to rises in sales industry wide
(Jacobe, 2013).
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5.4.2 Exhibit 5.4.2 - Trend in Self-Reported U.S. Average Daily Spending
(Jacobe, 2013)
5.4.3 Shopping Trends
Consumer shopping trends of recent have shown an increase in online sales across the
industry. According to IBM, consumer spending increased online 30 percent from 2011 to 2012.
Cyber Monday 2012 sales were up more than 36 percent compared to Black Friday sales for
2012. Many sales promotions enticed consumers to spend online and sales increase 43 percent
for Department stores and 25 percent for Apparel over 2011. More than 58 percent of consumers
used smart phones and 41 percent used tablets to shop on Cyber Monday (Fraim, 2012). One
reason that led to the increase was the offer of free shipping from many retailers. Internet sales
increased 22 percent for Christmas 2012 versus the previous year. Over 139 million consumers
shopped online for the holiday season for 2011. Amazon.com third party sellers had a 40 percent
increase in sales over the 2012 Christmas holiday season (Farfan, 2013). Shopping trends have
been heading towards increasing online sales for the past decade. Retailers are facing ever
changing shopping trends that have caused them to adapt.
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5.4.4 Government Regulations
Currently the National Retail Federation is opposing the settlement of credit card swipe
fees charged by Visa and MasterCard. Retailers who agree with settlement will split 7.5 billion
for the credit card fees charged. The suit was filed in 2005 by individual retailers and 19 trade
associations (Shearman, 2013). The government has stiff regulations when it comes to retailers.
For example, advertising is scrutinized and is not allowed to make false claims. The Federal
Trade Commission governs advertising and forces retailers to only make truthful claims. Also
consumer protection laws guard against retailers offering discounts to consumers and not
honoring them. Retailers can be held liable for not honoring such discounts (Lister, n.d.).
Consumer protection laws are some of the most important for the retail industry to keep in mind.
Some regulations that are important to recognize is that regular priced items can’t be advertised
as being a sale price. Regulations such as consumer protection laws keep the retailers in the
industry honest.
5.4.5 Economic Conditions
Economic conditions have a great deal of impact on the retail industry. Potential
consumers use disposable income to make purchases and economic conditions can affect amount
income available. One economic factor that affects the retail industry is employment
opportunities. Also bank interest rates can shake up the retail industry and create turmoil that will
influence consumer spending (Coles, 2012). Retailers can at times enhance the local economy
that it expands into by opening new stores and creating additional jobs for the people. Population
growth is a factor that is considered by the retail industry. For example, baby boomers are at a
point where they have moved towards retiring and not spending as much. The baby boomers
population is a large percent of the population and can affect the revenue of the retail industry
(Coles, 2012). JC Penny and Kohl’s will be impacted by the baby boomers retirement.
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In conclusion, there are many threats that are considered by retailers such as JC Penny
and Kohl’s. It’s important for retailers to know what elements that will impact their sales and
potential growth. Kohl’s has to consider these factors when exploring a merger with JC Penny.
Future economic conditions can create roadblocks for Kohl and JC Penny to flourish into the
future. Once Kohl’s plan out potential hedges for the risks associated with the merger then they
will be able to proceed. This will be necessary for the success of both organizations in the long
run.
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6 RISK ANALYSIS
6.1 Reputational Risk
A company’s reputation is the worth or quality of the company as viewed by other
people. When a company’s reputation is damaged it can cause stakeholders to lose trust in that
company. Even if a company is absolved of any wrongdoing, the damage to a company’s
reputation can cause a loss in profits, or damage in shareholder value. With the dramatic
evolution of technology, reputation management is even more important in today’s world than it
ever has been. Media coverage and the fast paced world of the internet and social media call for
companies to have developed risk management systems in place. (Diermeier & Loeb, 2013).
J.C. Penney’s reputation has recently taken many hits thanks to clumsy CEO
management that alienated employees, customers, and shareholders. In June 2011, Ron Johnson
replaced retiring CEO Mike Ullman. Johnson, a former Senior Vice President of Apple, Inc. had
planned on bringing a newer, hipper vibe to J.C. Penney. However, after a nearly $170 million
loss over the course of Johnson’s tenure, customers leaving the stores in droves, and taking a
severe hit to their reputation, the board of directors could no longer allow Johnson to continue
and officially fired him in April 2013 and reinstated Mike Ullman.
According to Ted Marzilli, senior vice president and managing director of BrandIndex,
J.C. Penney has a lower impression score than Kohl’s. The impression score was determined by
asking consumers if they have an overall positive or negative view of companies. J.C. Penney’s
impression score has continuously declined since 2011 while Kohl’s has stayed around the same
margin. (Marzilli, 2013).
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Exhibit 6.1: Impression Scores (Marzilli, 2013)
The acquisition of J.C. Penney by Kohl’s is likely to result in a decrease in reputation for
the Kohl’s division and an increase in reputation for the J.C. Penney division. Kohl’s currently
sits as the number one retail department store chain on Brand Keys 2013 Customer Loyalty
Engagement Index. Brand Keys performs an annual survey of around 40,000 consumers to
determine their emotional engagement with retail businesses. Kohl’s came in number one over
other companies such as Macy’s and Dillard’s. J.C. Penney ranked in last place. (Brand Keys,
2013). The likelihood of this risk materializing is high; this risk is expected to occur.
Consequences of reputational loss would mean a loss in consumers and revenue. A loss in
revenue could result in a loss of investors.
6.1.1 Managing Reputational Risk
While utilizing proactive marketing and known successful promotional campaigns, it’s
possible to mitigate reputational risk. Kohl’s is known for higher end items; however they
constantly have sales that bring down prices. Kohl’s already tops customer service surveys and
the system in place should be pushed heavily into the J.C. Penney division. Making customers
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feel welcome and important can go a long way in uncertain times; something Kohl’s has been
very successful in.
In addition, Kohl’s has a working system in place to bring customers back to the store:
Kohl’s Cash. The Kohl’s Cash system runs periodically and allows consumers to earn store
credit towards purchases for every $50 they spend in a single transaction. This campaign could
easily transition to the J.C. Penney division; perhaps coined JCP Bucks. This is assuming J.C.
Penney remains a separate division and its stores are not rebranded as Kohl’s stores.
A fresh marketing campaign designed at informing customers and shareholders of the
new direction the companies are going in would also be highly beneficial. If J.C. Penney is kept
as a separate division, then the marketing campaign should be designed to attract old clients and
new clients alike. Sales should be emphasized extensively to bring customers in and excellent
customer service, quality merchandise, and low prices should be used expansively to keep them
coming back.
6.2 Operational Risk
Whether a separate company or a conglomerate of organizations under an umbrella
corporation, every business has inherent operational risks that it must identify, quantify, and
manage. While Kohl’s and J.C. Penney both operate in a highly competitive retail industry, they
each have their own individual operational risks. The potential acquisition of J.C. Penney’s by
its competitor Kohl’s presents its own operational risks that could threaten the success of the
merger and the individual companies itself.
The retail industry and its occupants rely on an intricate roadmap of distribution channels
in order to receive the proper amount of the correct goods at the right time without making a
large dent in the company checkbook. Supply chain management is paramount in any
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organization that requires a vast amount of inventory to operate seamlessly from day to day.
According to an Ernst & Young report, supply chain disruptions are ranked at number 8 out of
the top 10 risks the retail industry currently faces in 2013 and beyond (Ernst & Young, 2013). In
fact, as seen in the exhibit 3, supply chain disruptions are predicted to happen more often going
forward.
Kohl’s Corporation has recognized the potential for disaster with a supply chain
disruption and has built a portfolio of vendors in order to prevent a complete dependency on
single vendors. According to their most recent SEC 10-K filing, Kohl’s received around 30% of
its merchandize from a purchasing agent and the remaining 70% from individual vendors (Kohl's
Corporation, 2013a). During the 2012 period, Kohl’s did not purchase more than 5% of their
merchandize from a single vendor (Kohl's Corporation, 2013a). While the most recent SEC 10-
K filing does not provide explicit details about its vendors, J.C. Penney receives its merchandise
from a variety of domestic and overseas vendors.
The potential acquisition of J.C. Penney’s opens Kohl’s Corporation up to double the
amount of merchandise to work with, double the amount of distribution centers, and a multitude
of vendors across the globe. A supply chain disruption could cripple the operational business of
either store or both together should that risk come to fruition. Without an easy, fluid distribution
flow from vendor to store, Kohl’s and J.C. Penney’s could face a number of problems from low
inventory levels to unexpected costs associated with rush delivery of needed inventories.
J.C. Penney had $2,341 million of merchandise inventory on hand and a cost of goods
sold of $8,919 million for an analytical total of $11,260 million merchandise bought and
sold/held (86.7% of their total sales for 2012) (J. C. Penney, 2013b). Kohl’s had $3,748 million
of merchandise inventory on hand and a cost of goods sold of $12,289 million for an analytical
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total of $16,037 million (83.3% of their total sales for 2012) (Kohl's Corporation, 2013a). As
evidenced by the numbers listed above, both corporations have a tremendous amount of
merchandise on hand and a quite sizable cost of goods sold on the income statement.
When working with such large quantities of inventory, the probability of a supply chain
disruption is quite possible. Vendors domestically and overseas could encounter an endless
number of unpredictable issues that could jeopardize that branch of the supply chain for the
stores across the nation or a subset of geographically similar stores. With Kohl’s potential
acquisition of J.C. Penney’s, the potential disruptions could double with the additional vendors
and distribution centers associated with the J.C. Penney stores.
The potential impact on operations could be detrimental to the organization. While a
small vendor with a small quantity of merchandise would not have a huge impact on the
organization, a disruption of an order for several tens to hundreds of thousands of dollars could
have ripple effect throughout. Kohl’s could not only lose out on possibly a good purchasing
contract with the vendor, it could also lose out on the immediate need for the merchandise. If a
hot, new trend should be appearing in stores in the coming weeks to ride the trendy wave and the
inventory is delayed due to a supply chain disruption, the store will lose out on the potential sales
associated with such merchandize and possibly be required to purchase the merchandise from an
alternate supplier at much higher costs due to short notice of demand.
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6.2.1 Exhibit 6.2.1: Sector Risk Radar (Ernst & Young, 2013)
6.2.2 Managing Operational Risk
With a high probability and the potential for serious impact on operations, Kohl’s
Corporation with J.C. Penney’s would need to find ways to manage the operational risk of
supply chain disruptions should the potential acquisition occur. Kohl’s should carry over to J.C.
Penney’s their philosophy of having a wide variety of vendors in order to prevent a reliance on
any vendor. A complete analysis of all vendors across both stores should be made to determine
overlap and determine percentages of merchandize purchasing for each vendor. The more
knowledge the executive management has on the vendors of both stores, the more equipped they
are to deal with the risk at hand.
Both stores are in the retail industry and heavily dependent on the successful operation of
its supply chain distribution. A single person or small department of people should be appointed
to monitor supply chain issues and concerns for both organizations. With someone dedicated to
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a particular focus, it allows for better discovery of a disruption during the beginning rather than
after the fact.
A third measure that could be used to lessen the impact of a supply chain disruption is to
invest in a quality software program to assist in the supply chain management function of the
organization. An internet based supply chain management system will give the management of
the organization the tools necessary to make quick decisions based on facts from past, present,
and future supplies of merchandise. With Internet based software, information is more readily
available to the users than in a traditional not Internet based software. The access to such
information would eliminate the miles between the company and its vendor’s thereby making
supply chain distribution much easier.
6.3 Procedural Risk
Procedural risks are described as any risk to a company’s operations due to a lack of
internal controls, accountability or fraud. Any of these situations makes a company vulnerable
and presents a risk to the infrastructure. Internal controls are an important part of risk assessment
in any business.
In Kohl’s Corporation most recent annual report, one of the risks described is the
unauthorized disclosure of consumer’s sensitive information. Kohl’s collects sensitive and
personal data from customers, employees and the company itself on a daily basis as part of their
normal business activity. However, the risk of this data being breached or misplaced is a real
threat to the integrity of the company. Despite the measures that are taken to protect this
information Kohl’s in constantly vulnerable to a security breach especially by those services that
are outsourced to third parties. If these risks become real threats the repercussions to the
company would be hard to recover from. They would lose credibility among the customers’ and
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many of them would be less likely to shop at their stores and website. This would create a
financial struggle for the company; it could bring litigation and liability as well as disrupt the
operations of the business (Kohl’s Corporation, 2013a).
Furthermore, the threat of employee fraud is a reasonable one for Kohl’s. In 2012, the
SEC charged a Kohl’s employee with “Assisting Financial Fraud at Carter’s Inc.” (U.S.
Securities and Exchange Commission, 2012). The employee was helping to cover financial
fraud by materially misstating the net income and expenses that was being reported. The amount
of discounts that Carter’s gave Kohl’s was being manipulated “in order to induce Kohl’s to
purchase greater quantities of Carter’s clothing” (U.S. Securities and Exchange Commission,
2012). While this situation directly affected Kohl’s, it also brings negative light to the reputable
company. This is not the first instance where Kohl’s has been involved in a fraud scandal their
employees.
JC Penny Corporation describes a similar risk. The concern is a security breach against
the data of the employees and the customers as well as the company information. Although they
have safeguards, there is no guarantee that the data is protected and are constantly exposed to the
risk of information being breached. If there were a breach in information, it would cause material
damage to the brand and reputation of the company. Furthermore, any of these claims can lead to
damage claims that would hurt the business financially. In 2008, GE Money issued a statement
that the personal information of around 650,000 JC Penny customers was compromised when a
computer tape went missing (Koenig, 2008). JC Penny has also had a share of employee fraud.
With the amount of employees that the corporation handles, it is always a threat to have
employee fraud. In 2012, a company employee was charged with stealing more than four
thousand dollars in cash from the store. This kind of attention creates a negative image for the
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company (Bergan, 2012). It is only one of the examples of employee fraud that has been
performed at this company.
6.3.1 Managing Procedural Risks
Having more efficient internal and system controls as well as fraud check points for all
the levels involved can prevent procedural risks. The companies can set up internal controls that
work well in order to prevent security breaches and fraud risk. This should be a top priority in
both companies’ risk assessment. The fact that both have encountered similar issues in the past
could create a loss of potential income due to lack of trust by the consumers.
In order to protect customer and employee data, a plan should be set out to eliminate the
possibility of a breach. This would involve restructuring of the internal controls in data
management. It is important to have a layered approach to protect the data. The people that are
involved in this breach have many different options to retrieve the information needed. There
should be a plan of attack so that if case one defense fails there is another one in place to fall
back on.
Besides the technological protections that need to be established like passwords and log
in, there are other options that these companies might consider. These can include disabling the
download function on the digital data or requiring a hard drive clean on a regular basis as well as
requiring secure passwords and changing them frequently. Since both JC Penny and Kohl’s also
rely on third party companies to protect their data, it is very important that they are aware of the
plan of attack of the third party partners and whom they are in turn sharing data with.
Furthermore, educating the staff on procedure in case of a data breach and recognizing potential
signs can help prevent this kind of security breach (Sanders, 2012). It is important to remember
that these procedures should all be part of the company’s internal systems and controls.
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There are ways to minimize employee fraud. Both Kohl’s and JC Penny have fallen
victims to this situation. Unfortunately, this draws negative attention to the companies and can
cause consumers to avoid shopping at their stores. Furthermore, it creates unexpected costs for
companies including loss of inventory and sales as well as a decrease in cash flow. There are
several safeguards that can be implemented in order to deter employees from committing fraud.
One of the most important ones is to make sure that the employees are aware of the
policies and procedures regarding fraud and the consequences that would follow if proven. This
alone is sometimes enough; however, other safeguards need to be implemented. Another
valuable implementation is the use of accounting internal controls. This would mean that a single
person is not allowed to control all the aspects of an accounting transaction. A practice that is
used often in retail stores is to have the person be responsible for the cash drawer that they are
assigned. The drawer is changed at the beginning of each shift and only the manager and the
employee are allowed to access it. Furthermore, in JC Penny’s case, the store should have a
procedure for claiming those types of promotions. These can include having both a manager and
employee sign the tickets and verify it with the merchandise at the end of the shift. (Lawlatte
2010).
6.4 Financial Risk
J.C. Penney’s market share has been adversely affected and negatively impacted by the
change in management. According to the 10K report for J.C. Penney, “The market price of our
common stock has fluctuated substantially and may continue to fluctuate significantly” (J. C.
Penney, 2013b). Furthermore, Kohl’s financial risk in acquiring J.C. Penney has the potential to
impact their financial holdings because of J.C. Penney’s debt being acquired. J.C. Penney’s
debt to equity ratio for 2012 was 48% when compared to 2010 that was 36% as well as their
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huge net loss in 2012. This means that J.C. Penney is using more debt to finance operating
activities. We also have to consider their cash to debt ratio, which was 31% in 2012 when
compared to 85% in 2010, which is a concern and threat to Kohl’s (J. C. Penney, 2013b). The
cash for J.C. Penney is thinning out significantly and quite risky for Kohl’s; the higher the cash
to debt ratio the better because the cash is available to cover the debt and currently J.C. Penney is
at 31%.
In identifying potential risks with the Kohl’s acquisition of J.C. Penney, we now have to
estimate the likelihood of the risks occurring and quantify their potential impact. With Kohl’s
acquiring J.C. Penney, there is an opportunity for Kohl’s to give life to J.C. Penney and mitigate
the downturn. The likelihood is high for customers to refuse the acquisition and the market to
take a further downturn thus, taking Kohl’s down with it. However, J.C. Penney customers are
waiting and willing to see a comeback, and with Kohl’s acquiring it, this may be the turnaround
the public has been waiting for and the market to rebound back to 2010 prices or higher. When
the market price is bottomed out and the competitor market shares are at their lowest, this is the
time for potential acquirers to get a hold of the competitor (Learning Markets, 2013). When you
compare Kohl’s market fluctuations and J.C. Penney’s for the last three years as seen below, J.C.
Penney’s market price has decreased by 32% in the last three years when compared to Kohl’s
who has remained steady at less than 1% share decrease; there is a potential for J.C. Penney to
rise again.
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J.C. Penney’s Market Fluctuations (CNN, 2013a)
Kohl’s Market Fluctuations (CNN, 2013b)
The likelihood of J.C. Penney’s negative debt to equity ratio and cash to debt ratio
affecting Kohl’s is significant and the potential is high along with other negative ratios and net
losses there is no doubt this could impact Kohl’s.
6.4.1 Managing Financial Risk
According to a Bloomberg Business week article on the risks of mergers and acquisitions,
both the acquiring and target companies need to set a financial and specific goal such as
increasing revenue by 10% as opposed to a non-specific statement that the company will do its
best to make the company better (Heinick, 2010). Once the negative drivers have been
identified, the merger and acquisition team needs to start making a list of how to manage the
items. Having the ability to be flexible but at the same time think about how the end result will
be obtained from Kohl’s pre-acquisition and post acquisition. The financial exposure is high, but
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forming a plan such as making the public aware that the merger will do great things for the target
company and/or negotiating the debt by lowering the interest rate. There are always risks with
merger and acquisitions, however it will depend on how they are identified and dealt with to
mitigate the risk outcome. The table below reviews the items that may be taken into
consideration as the pre-acquisition and post-acquisition goes into effect to minimize the impact
of any risk (PWC, 2012).
Pre-close action items Post-close action items
1) Identify the new post-combination risk exposure profile
1) Execute new and/or terminate old derivatives necessary to manage the new risk exposure
2) Develop a plan to address the new risk management strategy (i.e., risk or tolerate risk exposure)
2) Issue hedge documentation for new or re-designated hedges
3) Communicate and train employees on any new or revised risk management strategies
3) Converge accounting policy elections for consistent application
4) Discuss alternatives with counterparties for early termination and/or execution of new derivatives; establish new banking relationships if necessary to implement risk management strategy
4) Implement new systems and/or converge existing systems used in managing the new risk exposure
5) Consider any changes to systems and personnel, including transition of employees from acquiree
5) Identify ways to streamline and optimize the overall risk management process once it has been implemented
6) Identify new controls or changes to the existing control structure
6) Implement new controls to address new or revised risk management processes
7) Identify and communicate the financial reporting, tax, and systems implications of the proposed plan 8) Draft disclosures for the reporting period post-acquisition early to provide time for review and updates based on new risks, strategies and policies
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There are a few suggestions for reducing the potential solvency problems that may arise
with Kohl’s acquiring J.C. Penney. The net loss J.C. Penney is currently experiencing is because
overhead expenses are in excess of their gross profit. Kohl’s could minimize the number of
employees especially at the top where the compensation is higher. Kohl’s will have to invest in
a huge advertising campaign to give J.C. Penney a lift up to convince the public it is listening
and ready for the change. In accepting that J.C. Penney is not in an ideal place and that they
need to change, Kohl’s will have to make a big investment to change public perception, which
should help the bottom line and the market prices thereby increasing profits.
There is also the Merger and Acquisition Insurance which can protect the purchaser and
the seller. Here are a few reasons Kohl’s may need to obtain this kind of insurance:
1. To Extend the Post-Closing Seller Indemnification Survival Period, using Transaction Insurance to fund a covered claim.
2. Establish a Second Layer of Insurance Coverage, above the post closing indemnification amount, agreed to by the Seller.
3. Avoid Claims against the target company's Management Team, after the closing.4. Protect the Purchaser’s Investors, by meeting the obligations entrusted to the
purchaser.5. Reduce the Indemnification Requests of the Purchaser to lesser sums of money,
making the purchaser’s bid terms more competitive, from the seller’s viewpoint; Insurance is acting as an additional source of indemnification. (Greenpoint Agency, Inc., 2013)
This list obtained from GreenPoint Agency, Inc. (2013) should be considered to minimize
the potential for unforeseen circumstances and because J.C. Penney is currently experiencing
financial hardships.
6.5 Human Resource Risk
Kohl’s will create an increase in human resources risks by merging with JC Penny.
Synergy will play a role in some of the level of risk. If Kohl’s and JC Penny have synergy then
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the level of human risk will be lowered. Some of the factors that will play into it will be
employee health benefits, vacation time, and overall company structure. If the benefits are
entirely too different then the synergies will be affected and increase the exposure of risk.
Identifying some the risks associated with human resources before the merger would assist in
possible hedging.
According to Wall Street Journal, research shows that successful mergers involved
paying attention to human capital details (Bellavance, 2013). Some of the less successful
mergers didn’t involve much attention to the details of human capital. Examples of other human
resource risks are regulatory compliance and labor contracts. Kohl’s will have to be aware of any
regulatory compliance issues that JC Penny may have. One question to ask would be is JC Penny
in compliance with OSHA? Regulatory compliance of OSHA could lower the risk of having a
hazardous workplace (Loughran, n.d.).
Hazardous work conditions will add to the risk of workplace injuries and possible
workers compensation cases. Ultimately Kohl’s would be unaware if JC Penny is fully up to
OSHA compliance regulations. Also Kohl’s will have to evaluate if JC Penny has union
contracts or not with their employees. This could entail a bargaining agreement between JC
Penny and its employees (Loughran, n.d.). Kohl’s may run the risk of having to honor any
bargaining agreement that may be in place. This could important in the risk that may arise from
the merger with JC Penny.
So analyzing whether there is a union contract or not is very important. Once known,
Kohl’s will have to evaluate the contract and determine if it’s in compliance with JC Penny’s
balance sheet and income statements (Loughran, n.d.). In addition, it will be important for
Kohl’s to retain some of JC Penny’s key personnel for the merger to be effective. The human
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factor can be seen as one of the most important assets to the merger’s success. It would be
considered poor management practices to not focus on the retaining personnel.
Poor management can create higher employee turnover after the merger. Increased
employee turnover will be another possible human resource risk that can occur with poor
preparation. Inadequate implementation planning such as employee training can be a risk that
can transpire (Johannes & Strottman, 2013). People are an important asset in handling
unexpected risks that may arise (Rao, 2013). For example, multi-skilled employees can assist
with tasks that could stop uncertainties from the merger (Rao, 2013). According to research done
by Deloitte, 64 percent of managers say that employee resistance is the largest integration barrier
to get through (Johannes & Strottman, 2013). A great deal of the resistance will come from all
levels of management post the merger (Johannes & Strottman, 2013).
6.5.1 Managing Human Resource Risk
So it will be important for everyone to feel comfortable with the merger across the board.
Kohl’s will have to build employee confidence that the merger will be a great plan for both
companies and the success for the future. In addition, poor workforce planning can be an unseen
human resource risk. Kohl’s could under estimate the workforce needed to make the merger a
success. This would create some chaos and lead to disgruntled employees. Risk can be measured
in four stages. The stages of risks are catastrophic, major, moderate and minor.
Kohl’s will have to perform analysis of the risks that will be associated with human
resources. Analysis of the risk management will be important in determining what risks that will
need more focus. Risks that are considered catastrophic and major will need to be addressed.
Also depending on Kohl’s management, their risk tolerance may be higher or lower. This will be
important in going forward as to how much time will be dedicated to risk management.
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Integration of human resource functions will be challenging for Kohl’s to concur. Some
functions that will require attention are listed below.
Payroll Compensation and Benefits HR IT system & HR practices
In conclusion, human resource risks are just as important as other risks that will be
associated with the merger. Kohl’s will have to do its due diligence to be aware of what
potential risks will be involved with merging with JC Penny. Once the risks are known, then
Kohl’s will have to determine what level of risks they are prepared to tolerate. The risk level will
be important to address before moving forward. Synergies amongst the two companies will be a
factor in the amount risk that may occur. Kohl’s will be able to advance with the merger once all
issues are identified.
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7 Valuation- Kohl’s
7.1 Weighted Average Cost of Capital
The Weighted average cost of capital is shown as 6.94% with the CAPM calculation
which is part of the WACC formula found in Appendix 2where it shows Beta, Risk Free Rate
and Expected Market values obtained from Morningstar and the Kohl’s 10k annual report.
Kohl's
Weighted Average Cost of Capital = WACC = E/V * Re + D/V * Rd * (1-Tc)Re = cost of equity 8.27%E = market value of the firms equity 11579.52D = market value of the firms debt 4553V = E+D 16132.52E/V = % of financing that is equity 71.78%D/V = % of financing that is debt 28.22%Tc = Corporate tax rate 36.80%WACC = (71.78%*8.27)+(28.22%+5.63%)*(1-36.8%) 6.94%
7.2 Sources of Debt
Per Kohl’s 2012 10-K report, Kohl’s reported $4,561,000,000 in debt, of which,
$2,492,000,000 is comprised of long-term debt. Long-term debt consists of non-callable and
unsecured senior debt that matures over the next several decades. (Kohl’s Corporation, 2013a).
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Co
ntractual obligations consist of:
Operating leases include real estate taxes, insurance and maintenance costs as well as the
minimum rental payments. Purchase obligations are largely purchase orders for products. Other
consists of legally binding minimum lease and interest payments for stores set to open in 2013
and later, and also includes payments associated with technology agreements. (Kohl’s
Corporation, 2013a).
In September of 2012, Kohl’s issued $350 million of 3.45% notes with semi-annual
interest payments and which mature in February 2023. In anticipation of a debt issuance that
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matures in November 2012 ($650 million of 4% notes with semi-annual interest payments),
Kohl’s entered into interest rate hedges in December of 2010 and May 2011 to hedge their
exposure to risk. In addition to the debt issuance, Kohl’s paid $48 million to settle the hedges.
The unrealized loss on the hedges is recognized as interest expense at a rate of $5 million per
year over the ten-year life of the debt. (Kohl’s Corporation, 2013a).
Kohl’s has also provided their EBITDAR ratio along with a breakdown of their figures
(see figure below). EBITDAR is a ratio that gives an indication on a company’s capacity to pay
its debts. A high ratio could mean that the company may have problems paying off debt. Kohl’s
reported an increase in EBITDAR from 1.99 to 2.23 (2011 to 2012) due to higher outstanding
debt, which included a $350 million debt issuance in September 2012. (Kohl’s Corporation,
2013a).
Another financial measure important to reviewing a company’s debt is the debt to equity
ratio. This is a relatively simple ratio, which divides total debt by total equity. Kohl’s currently
has a 75% debt to equity ratio. This is higher than the industry average of 34%; however, when
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compared to other major department stores like J.C. Penney (94%) and Macy’s (115%), it is
lower to comparable companies. (CSI Market, 2013).
7.3 Sources of Equity
Equity financing allows for a corporation to raise capital for activities in exchange sell a
percentage of ownership in the company. Investors can utilize this opportunity to gain some
ownership or additional ownership into the corporation. Kohl’s can issue either preferred or
common stock to receive the ideal capital they need to fund the acquisition of JC Penny. So this
will require Kohl’s to surrender some of the business to acquire enough money to potentially
acquire J.C. Penney.
Equity financing can at times create uncertainty amongst existing investors. This will
depend on the investor’s strategies. Some shareholders will be ecstatic to be able to gain
additional ownership into the company. So there will be a 50/50 risk that shareholders will take
the equity financing activities in an idyllic manner. Kohl’s currently has 222 million shares
outstanding and would have to increase the amount shares outstanding to fund the acquisition
activity. There currently are 589 institutions holding Kohl’s outstanding shares of stock (Yahoo!
Finance, 2013a). The current breakdown of ownership shares outstanding is as follow:
Owners of Shares Outstanding
% of Shares Held by All Insider and 5% Owners: 7%% of Shares Held by Institutional & Mutual Fund Owners: 89%% of Float Held by Institutional & Mutual Fund Owners: 96%Number of Institutions Holding Shares: 589
(Yahoo!Finance, 2013a)
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This information will be important to consider when increasing the amount of additional
shares outstanding. Some institution or person that buys enough stock in Kohl’s could gain the
adequate amount of ownership to make influential decisions. So this would have to be kept in
mind when increasing the amount outstanding shares. Kohl’s Board of Directors began to payout
dividends to shareholders in 2011. They began by paying $.25 cent per common share of stock.
Dividends were increased to $.32 cent per common share in February of 2012 and increased
again to$.35 cent per common share in 2013 (Kohl’s Corporation, 2013a).
This proved to shareholders that Kohl’s management has confidence in the future growth
of the organization. Kohl’s has over the past several months repurchased over 8 million in
shares outstanding. This buyback freed up this stock to be reissued and opened the door for
equity financing for the J.C. Penney acquisition. The average share price of this repurchase was
$44.79. Also Kohl’s repurchased 46 million shares of common stock in 2011 and 26 million
shares of common stock in 2012. The approximate combined value of the common stocks
repurchased in 2011 and 2012 was $3.6 billion. They are in a process of buying back stock for up
to the next 3 years (Kohl’s Corporation, 2013a). Seen below is the number of shares purchased
since October 2012. They have more than enough stock repurchased to complete an acquisition.
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(Kohl’s Corporation, 2013a)
It would be ideal for Kohl’s to utilize stock that they have on hand to fund the
acquisition. They could use some of the stock on hand that they repurchased as of 2011. The
stock is worth upwards of $4 billion that is on hand from the repurchases that were made over
the past few years (Kohl’s Corporation, 2013a). Supplementary capital will be needed so Kohl’s
could build the necessary extra capital from possibly increasing shares outstanding. Many
shareholders will be potentially ok with the additional shares since Kohl’s has shown that they
will perform buybacks when needed. Once the acquisition is completely successful Kohl’s can
begin to buy-back stock to assist with the stock price.
There will be a possibility that the stock price could drop once the acquisition is
announced. The same could be said for the potential for the stock price to increase depending on
the market’s outlook about the merger/acquisition of J.C. Penney. Lastly, the dividends that
Kohl’s have begun to pay since 2011 will entice some investors to take a risk and purchase the
stock. Some investors are motivated to purchase stock that offer dividends to their shareholders.
The offering of dividends indicates that Kohl’s is heading in a good direction and that they are
very profitable. Organizations tend to only pay out dividends when they are profitable and feel
like rewarding shareholders that possess their stock. Kohl’s during 2012 paid out $.32 cent per
share for each quarter that equaled to over 300 million for the year. The payout of the dividends
by each quarter can be located in the table below (Kohl’s Corporation, 2013a).
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7.4 Complexity
Kohl’s has two segments of revenue streams. The first form of revenue originates from
store sales. The second portion of revenues derived from online sales. Majority of Kohl’s
revenue is generated from store sales and the remaining is from ecommerce sales. Kohl’s has
several stores across the United States and has expanded on this year to year. Their management
focus is to open stores each year across the United States. The table below displays Kohl’s total
stores for each region. Since 1992 Kohl’s have increased in stores by 1,076. The stores in the
West region has grown the most overall. They closed the year with 1,155 stores countrywide.
This was up from the 1,146 stores that they closed the year with in 2012.
Stores by Location
Stores by Region
1992 2002 2010 2011 2012 2013
Midwest 79 196 292 300 301 305 Mid-Atlantic
- 57 106 110 113 115
Northeast
- 77 143 147 153 153
South Central
- 67 138 143 147 148
Southeast
- 49 173 183 188 189
West - 11 237 244 244 245 Total Kohl’s
79 457 1,089 1,127 1,146 1,155
(Kohl’s Corporation, 2013a)
E-commerce
Some of Kohl’s exclusive brands that they offer are Food Network, Marc Anthony,
Jennifer Lopez, Rock & Republic and Simply Vera Vera Wang. Kohl’s ecommerce site began in
2001 and has grown over 40%. Online sales were over 1.4 billion dollars and contributed to 7%
of overall sales for 2012 (Kohl’s Corporation, 2013a). The online store carries much more
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products than the store locations. They are focusing on increasing their mobile and online sales
for the future. This has been the trend amongst savvy shoppers going forward. So Kohl’s will try
to capitalize off the move towards to online shopping for consumers. Cyber Monday has shown
to be growing midst consumers year after year.
Store Front
Back to school season contributed to 15% of the sales for 2012. Approximately 30% of
annual sales are made during the holiday season and is considered a big season for the
organization (Kohl’s Corporation, 2013a). The total net sales for 2012 were $19.3 billion. Kohl’s
annual sales growth for 2012 was 5.1%. In 2010, Kohl’s experience one of their biggest growth
spurts with 7.1% annual growth for the year (Kohl’s Corporation, 2013a). Below is a table of net
sales for the past three years. A drop in sales per square foot was experienced in 2012 when
compared to the previous years. This drop in sales excludes the online sales segment of Kohl’s.
The sale per square foot informs management of what portion of sales are made for each
location. It will be important for Kohl’s to focus on increasing the sales per square foot for each
storefront. Even with the drop in sales per selling square foot, overall annual sales growth was
2.5% (Kohl’s Corporation, 2013a). This could be due to the new stores that were opened in the
year. Moving forward the revenue could continue to growth with the additional acquisition of
J.C. Penney and some of their consumers.
(Kohl’s Corporation, 2013a)
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8 VALUATION – J.C. PENNEY
8.1 Book Value
The book value is calculated by subtracting the preferred stock of a company from the
stockholder’s equity. J.C. Penney’s total book value is $3,171,000,000. JC Penny did not have
any outstanding preferred stock.
Total Book Value
Stockholder’s Equity (SE) $3,171,000,000 SE - Preferred Stock O/S
Preferred Stock O/S 0
$ 3,171,000,000
8.2 Book Value Per Share
The book value per share is the minimum value of the equity of a company. It is
calculated by dividing the total book value by the outstanding common stock. The book value
per share is $14.46.
Book Value/Share
Total Book Value (TBV) $ 3,171,000,000 TBV x Common Stock O/S
Common Stock O/S 219,300,000
$ 14.46
8.3 Market Value
Total market value is the total of a company’s outstanding shares. The market value for
JC Penny is $4,322,403,000. This calculated by taking the current market value of the stock and
multiplying it by the outstanding common shares.
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Total Market Value
Current Market Value (CMV)
$ 19.71 CMV x Common Stock O/S
Common Shares O/S 219,300,000
$ 4,322,403,000
8.4 Intrinsic Valuation
In deterring the intrinsic value for J. C. Penney, there were many steps and calculations to
prepare in order to get an accurate valuation. “The weighted average of the after-tax component
costs of capital—debt, preferred stock, and common equity. Each weighting factor is the
proportion of that type of capital in the optimal, or target, capital structure” (Brigham &
Ehrhardt, 2011).
The weighted average cost of capital equated to 15.42%, which is the
cost of overall capital the company is paying for their overall equity and
debt. The figures such as Beta, free market rate and expected market return
were obtained from the J.C. Penney 10-K report for the fiscal year ended
January 2013 and Morningstar. See 12.1.9 in the Appendix.
The Cost of Equity is one part of the WACC analysis. We will be using the Capital Asset
pricing model which is “A model based on the proposition that any stock’s required rate of
return is equal to the risk-free rate of return plus a risk premium reflecting only the risk
remaining after diversification” (Brigham & Ehrhardt, 2011).
This part of the equation is to determine what stockholders require in return for making
the risky business investment. In the case of J.C. Penney, the cost of equity is 20.13%. The
same can be said for the Cost of Debt as seen in 12.1.9 in the Appendix.
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8.4.1 Forecasted Financial Statements
Our preparation of the forecasted financial statements for J.C. Penney involved taking 4
years of historical data. In doing this, we found that 2012 was an anomaly because of the
significant decrease in sales of more than 24%. However, prior to 2012, J.C. Penney was in
good condition, and with this merger, we feel that J.C. Penney can make a turnaround from 2012
and post a small but positive growth of 5% for 2013. It will take a couple of years for J.C.
Penney to be back to pre-2011 figures and we feel that 2013 will be a positive start. There was
no use in using the fiscal year ended January 2013 in trying to determine our forecasting because
of the sharp decrease. We believe this will not occur again once Kohl’s has acquired J.C.
Penney. We used figures in our forecasting that were comparable to 2011 because our intrinsic
value would be negative in using the 2012 figures thus creating a negative intrinsic value
because of the sharp decrease in net operating income and sales. It was proving to be a difficult
task using equations to value a company with negative Free Cash Flow and instead opted to use
2011 financial figures.
8.4.2 Exhibit 10.4.2: Forecasted Financial Statements for J.C. Penney
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J.C. PENNEY CO INC (JCP)BALANCE SHEET
Fiscal year ends in January 2013 USD in millions except per share data.Assets Actual Forecasted
Current assets Cash and cash equivalents $121.00 $169.00 Short-term investments 809.00 809.00
Total cash 930.00 978.00 Receivables 57.00 125.00 Inventories 2,341.00 3,213.00 Deferred income taxes 106.00 Prepaid expenses 249.00 249.00
Total current assets 3,683.00 4,565.00 Property, plant and equipment Land 310.00 310.00 Fixtures and equipment 2,132.00 2,132.00 Other properties 5,791.00 5,791.00 Property and equipment, at cost 8,233.00 8,233.00 Accumulated Depreciation (2,880.00) (2,880.00)
Property, plant and equipment, net 5,353.00 5,353.00 Other long-term assets 745.00 745.00 Total non-current assets 6,098.00 6,098.00
Total assets $9,781.00 $10,663.00 Liabilities and stockholders' equity
Current liabilities Capital leases $26.00 $26.00 Accounts payable 1,162.00 1,190.00 Other current liabilities 1,395.00 882.00
Total current liabilities 2,583.00 2,098.00 Non-Current Liabilities Long-term debt 2,956.00 3,254.00 Deferred taxes liabilities 388.00 1,192.00 Other long-term liabilities 683.00 784.00
Total non-current liabilities 4,027.00 5,230.00 Total liabilities 6,610.00 7,328.00 Stockholders' equity Common stock 110.00 110.00 Additional paid-in capital 3,799.00 3,799.00 Retained earnings 380.00 581.00 Accumulated other comprehensive income (1,118.00) (1,155.00)
Total stockholders' equity 3,171.00 3,335.00 Total liabilities and stockholders' equity $9,781.00 $10,663.00
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J.C. PENNEY CO INC (JCP) FORECASTED INCOME STATEMENTFiscal year ends in January. USD in millions except per share data.
Actual Forecasted 2013-01 2014-01 Revenue $12,985.00 $18,647.00 Cost of sales 8,919.00 11,339.00 Gross profit 4,066.00 7,308.00 Operating expensesSales, General and administrative 4,535.00 6,047.00 Other operating expenses 841.00 831.00
Total operating expenses 5,376.00 6,878.00 Operating income (1,310.00) 430.00
Interest Expense 226.00 226.00 Other income (expense) Income before income taxes (1,536.00) 204.00 Provision for income taxes (551.00) 73.00 Net income from continuing operations (985.00) 131.00 Provision for income taxes (551.00) 73.00 Net income $(985.00) $131.00
8.4.3 Present Value of Operations
Our present Value of Operation is $4.5 million. The outlined steps below represent the
steps taken to obtain our Value of Operations. In our analytical procedures we also determined
J.C. Penney’s intrinsic value of shares, which equates to $11.26 per share along with the intrinsic
value of operations at $5.3 million. We used our 515 Accounting Textbook from Brigham &
Ehrhardt to obtain help and identify the formulas needed for the steps needed in our outcome of
Intrinsic Value.
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8.4.4 Exhibit 10.4.4: J.C. Penney Value of Operations
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9 PERFORMANCE MEASUREMENTS
9.1 Asset Utilization
Asset utilization ratios give management and investors a measurement of how capable a
company is at using its assets to make money. Asset utilization measurements are detailed
efficiency measurements for the company; that indicate how a company’s sales are generated in
relation to operating variables like, inventory, personnel, and expenses. These ratios also focus
mainly on efficiency.
9.1.1 Sales to Working Capital
The sales to working capital ratio shows the amount of cash needed to sustain a certain
level of sales. A company has to keep a certain level of investment in inventory and accounts
receivable, which accounts payables are offset against. Companies keep a certain amount of
working capital to sales that should remain relatively constant, even as sales levels change. The
sales to working capital ratio is the measure of the relationship of the sales to working capital. It
is typically shown on a trend line to easily identify spikes and dips. “An increasing sales to
working capital ratio is usually a positive sign, indicating the company is more able to use its
working capital to generate sales” (Spireframe, 2013, para 2). This measurement is calculated by
dividing annualized net sales by average working capital (accounts receivable plus inventory
minus accounts payable). (Accounting Tools, 2013).
The sales to working capital ratio for Kohl’s and J.C. Penney both went down from 2011
to 2012. In the case of J.C. Penney, they reduced inventory from 2011 to 2012; the reduction in
inventory could have resulted in fewer sales as customers went to competitors for merchandise.
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In the case of Kohl’s, they saw an increase in accounts payable, which would indicate an
increase in debt.
9.1.2 Days of Working Capital
The days of working capital ratio is a measurement of the length of time it takes a
company to convert its working capital into revenue. This measurement is a good gage of
deviations in the efficient use of working capital. The smaller the number of days indicates a
better use of working capital. This measurement is calculated by adding the current balance of
accounts receivable to inventory minus accounts payable. Then taking that amount and dividing
by sales per day (annual sales divided by 365).
Though Kohl’s days of working capital increased from 2011 to 2012, they are still far
under J.C. Penney’s days of working capital. This would indicate that Kohl’s does a better job of
utilizing its working capital and has a faster turnaround time of converting its working capital
into revenue.
9.1.3 Sales per Person Ratio
The sales per person ratio is not a very detailed ratio, but it gives a general indication of
how much sales are brought in, in relation to the number of FTEs. The higher the ratio, the more
efficient the company is considered to be and the more sales per employee it pulls in. The ratio
is calculated by dividing the annualized revenue by the total full-time equivalents (FTEs).
Both companies increased their sales per employee from 2011 to 2012. However, Kohl’s
succeeded with a reduction in employees and still achieved an increase in revenue. J.C. Penney
also had a reduction in employees, unfortunately the also saw a reduction in revenue.
9.1.4 Asset Utilization Table
Asset Utilization MeasurementsKohl’s J.C. Penney
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2011 2012 2011 2012Sales to working capital ratio 24.19% 17.57% 5.16% 3.14%Days of working capital 1,509 2,077 7,075 11,620Sales per person (employee) $213,953 $227,879 $171,834 $228,912
9.2 Operating Performance
Operating performance measurements relate to how well a corporation converts its assets
into revenue and how proficiently the corporation turns its sales into cash. These ratios typically
tell how proficiently and successfully a corporation is using its assets to produce sales and grow
stockholder worth.
9.2.1 Gross Profit Percentage
The gross profit percentage is a way for companies to see the cost of revenue without
direct materials. Direct materials are materials associated with the production of a product. The
higher the percentage, the more efficient the company is considered to be managing gross profit.
The calculation for gross profit percentage is revenue minus direct materials divided by revenue.
(Bragg, 2011).
Neither J.C. Penney nor Kohl’s have very high gross profit percentages. Also, both
companies saw a decrease from 2011 to 2012 so their cost of goods sold increased over the
course of the year. This is an area that Kohl’s can do some analysis in to see where
improvements can be made.
9.2.2 Operating Profit Percentage
Operating profit percentage gives the percentage of sales that become profit, but excluding
miscellaneous income and tax expenses. This percentage shows the amount that a company is
earning revenue from standard operations. This percentage can be found by adding the cost of
goods, to sales, general, and administrative expenses and subtracting from sales. That total is
then divided by sales.
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Again, both companies saw a decrease from 2011 to 2012. This means that their operating
income went down due to selling and administrative expenses going up. J.C. Penney is
especially having a hard time keeping expenses under control. The Kohl’s acquisition of J.C.
Penney will have to do in-depth audits of these areas to get costs under control and income up.
9.2.3 Net Profit Percentage
The net profit percentage gives the amount of profit resulting from all operating,
financing, and other activities that a company has incurred during the reporting period. Though
it is not an indicator of a company’s cash flows, it is a commonly used ratio for assessing a
company’s performance. This percentage is calculated by dividing net income by revenue.
(Bragg, 2011).
Companies should strive for an upward trend between accounting periods. A downward
trend indicates financial problems. Both companies saw a decreasing trend from 2011 to 2012;
however, JCP numbers indicate a serious financial issue. Again this is an indication that both
companies are having issues with their expenses compared to revenue and need to concentrate on
finding solutions to reduce costs while increasing profit.
9.2.4 Operating Performance Table
Operating Performance MeasurementsKohl’s J.C. Penney
2011 2012 2011 2012Gross profit percentage 38.18% 36.26% 36.03% 31.31%Operating profit percentage 11.48% 9.80% 99.91% -10.09%Net profit percentage 6.21% 5.24% -0.01% -5.71%
9.3 Cash Flow Measurements
9.3.1 Cash Flow from Operations
This ratio examines the cash flows related to the operating income of the organization.
Based on a scale of one, anything lower than one would present issues with the organizations
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cash flows related to the operating income. As the textbook states, less than one is “indicative of
substantial noncash expenses or sales” (Bragg, 2011).
As shown in the table below, cash flow from operations ratio for increased from 1.36 in
2011 to 1.44 in 2012. J.C. Penney has been struggling with the last 2 years being below 1
indicating they have large non-cash expenses.
9.3.2 Cash Flow Return on Assets
This ratio compares cash flows to the total assets of the organization “to determine the
amount of cash that a company is generating in proportion to its asset level” (Bragg, 2011).
Kohl’s has been generating an average of 13% cash flow return on assets over the last 2
years. J.C. Penney, on the other hand, has steadily decreased from 4.4% to -0.9% further
illustrating cash flow problems with the organization.
9.3.3 Cash to Working Capital Ratio
This ratio determines how much of an organizations workings capital is accounting for in
cash and cash equivalents.
Kohl’s has unfortunately been decreasing over the last 2 years from 54.2% to 24.6%. The
decrease in this ratio indicates that Kohl’s has been steadily using their cash and cash equivalents
over the last two years. J.C. Penney, on the other hand, closed out fiscal year 2012 with an
84.5% cash to working capital ratio indicating there cash and cash equivalents is a substantial
portion of their working capital.
9.3.4 Cash Flow Measurements TableCash Flow Measurements
Kohl’s J.C. Penney2011 2012 2011 2012
Cash Flow from Operations 1.36 1.44 -318.50 .32Cash Flow Return on Assets 13.7% 13.1% 4.3% -0.9%Cash to Working Capital 54.2% 24.6% 64.8% 84.5%
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9.4 Solvency Measurements
9.4.1 Times Interest Earned
This ratio represents an organization’s ability to pay its interest expense on debt and how
much additional cash flows are available.
Kohl’s has a substantial ability to pay for its interest obligation on its debt. They closed
out fiscal year 2012 with a 5.53 times interest earned indicating their cash flow is more than 5
times that of their interest expense. J.C. Penney appears to have a substantial problem with their
times interest earned ratio. They closed out fiscal year 2012 with a -0.39, which means they
have a substantial risk of defaulting on their obligations without an overhaul of their cash flow
problems.
9.4.2 Debt to Total Assets
This ratio presents a comparison between an organization’s overall debt to their total
assets on the financial statements. The lower the ratio the less debt an organization has
compared to their total assets.
While Kohl’s has been steadily increasing their debt to total assets ratio, they are still at a
56.5% indicating their total debt is about half of what they have in assets. J.C. Penney’s has also
been steadily increasing; however, they are taking on a much higher percentage of debt
compared to their assets. For fiscal year 2012, J.C. Penney had a debt to total asset ratio of
67.6%.
9.4.3 Cash Debt Coverage Ratio
This ratio is extremely important as it presents “the ability of a company to pay its debts”
(Bragg, 2011). If an organization is unable to pay its debts, the company will default and be at
risk of bankruptcy.
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Kohl’s has a very high cash debt coverage ratio at 574.5% indicating they have sufficient
income to cover their future obligations putting them at low risk of defaulting on their debt. J.C.
Penney closed out fiscal year 2012 with a -225.9% indicating their earnings are not even close to
covering their future obligations. With such a high cash debt coverage ratio, J.C. Penney is at an
extremely high risk of defaulting on their debts without a substantial overhaul of their operations.
9.4.4 Solvency Measurements Table
Solvency MeasurementsKohl’s J.C. Penney
2011 2012 2011 2012Times Interest Earned 6.51 5.53 2.15 -0.39Debt to Total Assets 54.0% 56.5% 64.9% 67.6%Cash Debt Coverage 721.7% 574.5% -0.9% 225.9%
9.5 Liquidity Ratios
Liquidity measurements are used by companies to find out if the company can pay off short-
term debts. It can be a very good indicator of the financial health of the company. It gives
investors a good idea as to whether or not the company might be a worthy investment. The
general rule is that the higher the ratio is the greater the safety margin of the company.
9.5.1 Net working capital
Working capital determines a business’s efficiency and short-term financial health. This ratio
measures if their short-term assets can cover a company’s short-term debt. This ratio gives
investors an idea of how efficient the company’s operations are.
Both Kohl’s and JC Penny have positive net working capital meaning that they are bale to
cover their current liabilities with their liquid assets. However, since both Kohl’s and JC Penny's
capital has decreased between 2011 and 2012 it could be a red flag and needs to be analyzed in
the coming years.
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9.5.2 Current ratio
The current ratio measures how likely the company can pay any short-term obligations
utilizing their short-term assets. Short-term obligations refer to anything within a twelve-month
period. The higher the ratio, the more capable the company is of paying off its debt. It gives
investors an idea of how efficient the company is in turning the product into cash.
Both Kohl's and JC Penny have ratios over 1, which indicates that the company is able to pay
its debt. Kohl's ratio increased slightly which shows better management while JC Penny's
decreased. This would be something to keep an eye on for JC Penny so that the ratio does not fall
too low and a risk can be address on a timely manner.
9.5.3 Quick or acid test ratio
This measures if the company has sufficient short-term assets to pay off any immediate
liabilities. This ratio does not allow inventory assets to be included. If a company has a ratio
higher than one is considered risky and should be analyzed with caution.
Both Kohl's and JC Penny have a ratio lower than one, which makes them less risky.
Since their ratios have decreased from 2011 to 2012 it shows that they are becoming safer
investments.
9.5.4 Liquidity Measurements Table
Liquidity MeasurementsKohl’s J.C. Penney
2011 2012 2011 2012Net Working Capital (millions) $2,222 $2,184 $2,325 $1,100Current Ratio 1.85 1.86 1.84 1.43Quick or acid-test ratio .62 .38 .70 .42
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9.6 Activity Ratios
Activity ratios are used to measure how efficient a company is based on how its assets are
used. These ratios show investors how well the company’s management is at generating revenue
or cash from its resources.
9.6.1 Inventory turnover ratio
This ratio measures the efficiency of a company’s ability to manage and sell inventory. A
high inventory ratio means that the company is strong in sales, while a low ratio means that the
company is efficiently managing and selling its inventory. The faster the inventory sells the
more funds the company has readily available.
Both Kohl's and JC Penny have around the same inventory ratios. This means that they are
both efficient at managing and selling their inventory and are comparable to each other. These
ratios are compared to industry standards.
9.6.2 Average age of inventory
The average age of inventory refers to how long it takes a company to sell the inventory that
is currently holding. If there is a large average age ratio it means that the inventory is not being
properly managed and the company may not be able to sell its products. If the ratio is decreasing
it may indicate that there is low inventory. This ratio helps purchasing managers make buying
and pricing decisions.
While Kohl's ratio decreased between 2011 and 2012, JC Penny's increased. This could mean
that Kohl's is maintaining a lower inventory while JC Penny may be holding too much. The
purchasing manager needs to look at why the ratios have changed and how they compare to
sales.
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9.6.3 Average collection period
The average collection period refers to how long it takes a company takes to receive its
payments on its receivables from clients or customers. Having a lower average collection period
is ideal because it means the company does not take long to turn their receivables into cash.
Kohl's has a lower collection period meaning that it is in a better position to turn its
receivables into cash. JC Penny's ratios are higher, meaning that it takes them longer to convert
the receivables into cash. On the positive side the ratio has not increased for JC Penny and has
decreased for Kohl's
9.6.4 Activity Measurements Table
Activity MeasurementsKohl’s J.C. Penney
2011 2012 2011 2012Inventory Turnover Ratio 3.5 3.7 3.6 3.4Average Age of Inventory 103.42 98.15 101.39 107.35Average Collection Period 1.4 1.3 7.1 days 7.1 days
9.7 Return on Investment Measurements
The return on investment measurements include return on equity, dividend payout ratio,
return on assets, economic value added, and asset turnover ratio. These measurements give
investors an inside look into the profitability of the organization in question. Many investors use
these tools to make an informed decision about whether or not to proceed with investing into a
company.
9.7.1 Return on Equity (ROE)
This formula provides shareholders an insight into how much of a profit a company has
created when it pertains to the investment that shareholders’ invested. Return on equity can also
be known as return on net worth. The return on equity equation is Net Income/Shareholder’s
Equity. The higher the percentage on ROE the better the company has been able to convert the
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money shareholders invested to profits. Investors can utilize this formula to compare companies
across their industry. Kohl’s shows a successful percentage of profits compared to shareholder’s
equity that was invested. J.C. Penney on the other hand shows a negative profit when associated
with investments from shareholders. In 2012, J.C. Penney’s return on equity was a negative 31
percent compared to Kohl’s 15 percent.
9.7.2 Dividend Payout Ratio
The dividend payout ratio provides the earnings paid to shareholders in the form of a
percentage. The formula is expressed as (Dividends / Net Income) equals dividend payout. The
dividend payout ratio gives investors an idea about how well the company pays out dividends
compared to the income made. This formula is good for older companies and organizations in
certain industries. Companies in older stable industries tend to payout dividends to their
shareholders. The Board of Directors is responsible for declaring dividends to be paid to
shareholders. This can be a helpful formula to use if you are an investor looking to receive
dividends from your investment. Investors saw a decrease in the percentage of dividend payouts
from 2011 to 2012 for J.C. Penney. Many investors would be happy to receive a dividend payout
from both Kohl’s and J.C. Penney. Kohl’s appears to be consistent with the percentage of
dividends paid out from year to year according to 2011 and 2012. Kohl’s dividend payout
increased by 7 percent from the previous year when compared to net income. They maintain a
solid percentage of returns to shareholders related to profits made by Kohl’s.
9.7.3 Return on Assets (ROA)
Return on assets ratio gives an insight into how well a company is utilizing its assets to
generate profits for the company. This can also be used to determine how profitable a company
maybe. The equation is calculated as net income divided by total assets. ROA can be used to
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compare companies in the same industry. The higher the ROA the more the company is earning
of its investments with using less money. This ratio gives an idea of management’s success at
providing a return using the assets that they have. A company is considered profitable the higher
the ROA is for the company. ROA is also known as return on investment. It’s a great tool for
investors to use to figure out how profitable a potential investment may be to them. Some
investors look at historical ROA to compare and predict the potential future returns on assets.
Kohl’s had a 6.9 percent return on assets for 2012 and J.C. Penney had a negative 10 percent
return on assets for 2012. Ultimately investors would be content with seeing a positive return
such as 6.9 percent on Kohl’s return on assets. Investors wouldn’t be interested in investing
further into J.C. Penney due to their increase in negative returns on assets for the past two years.
9.7.4 Return on Investment Table
Return on Investment MeasurementsKohl’s J.C. Penney
2011 2012 2011 2012Return on Equity 18% 15% (4%) (31%)Dividend Payout 23% 30% 114% 4%Return on Assets 8.1% 6.9% (1%) (10%)
9.8 Market Performance Measurements
The market performance measurements offer the perception into the success of the
organization’s securities. The performance measures used are sales to stock price ratio,
price/earnings ratio, earnings per share, and quality of earnings ratio.
9.8.1 Sales to stock price ratio
This ratio provides a comparison of sales to the price of stocks the company is offering in
the marketplace. The ratio looks at the performance value of the stock. The ratio is calculated as
stock price divided by revenue per share. The ratio only takes into account the stock price and
revenue per share. It doesn’t take into account the debt a company may have or not. The sales to
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stock price ratio can be used to compare companies in the same industries. A low price compared
to sales can indicate that a company’s stocks may be undervalued and possibly be a good
investment. Kohl’s would be considered to have an undervalued stock price when it relates to
their sales to stock price ratio. Their ratio is under 1 for 2011 and 2012. J.C. Penney has an
overvalued stock price when utilizing the ratio. J.C. Penney sales to their price of stock are high
when using the formula.
9.8.2 Price/earnings ratio (P/E)
The price earnings ratio can assess an organization’s share price compared to its earnings
per share. The ratio is calculated as market value per share price divided by earnings per share.
Like many of the other market performance measurements, the PE ratio is utilized better to
compare companies in the same industries. The higher the PE ratio the more it’s considered that
investors are anticipating future growth. PE ratios can be unreliable due to some of the figures
used can be manipulated. Many investors use this ratio to predict future PE ratios and possible
future organizations to invest in. The PE ratio can be looked at as one of the more popular used
analysis tools by investors. If the relationship between the share price and earnings per share
appears to be profitable then an investor may look into purchasing the stock. J.C. Penney has a
negative price earnings ratio of 4.39 for 2012.
9.8.3 Earnings per share
Earnings per share can be a gauge of how profitable a company may be. The formula is
calculated as net income minus dividends on preferred stock divided by average outstanding
shares. The earnings per share analysis are used to calculate the price earnings ratio. So this ratio
can be considered important and is widely used by investors across the board. Earnings per share
can be manipulated also since net income is used in the formula. On the other hand average
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shares outstanding will be different for each company that is observed. It can be important to use
several tools when valuing an organization. This is also best used when comparing like
companies in the same industry. Investors use historical growth rates to predict future earnings
per share. So earnings per share will vary for Kohl’s and JC Penny even though they are in the
same industry. Kohl’s earnings per share for 2012 were $4.19 and J.C. Penney was a negative
$4.49 per share. According to Kohl’s earnings per share, they are a profitable company when
compared to J.C. Penney.
9.8.4 Market Performance Measurements Table
Market Performance MeasurementsKohl’s J.C. Penney
2011 2012 2011 2012Sales to Stock Price Ratio 0.56 0.48 2.56 1.90Price/Earnings Ratio 11.40 10.26 (50.21) (4.39)Earnings per Share 4.33 4.19 (.70) (4.49)
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10 CONCLUSION AND RECOMMENDATIONS
10.1 Optimal Capital Structure
The table below reflects the outcome of the optimal capital structure obtained after
preparing various formulas and inputs from 0% debt to 90% debt. We obtained the table and
formulas by using our Financial Management textbook from Bringham chapter 15.5 and
followed the table provided. As you can see the optimal capital structure is found with 40% debt
and 60% equity. The table below reflects that the number of shares has decreased but the stock
price is it’s optimal value creating shareholder wealth.
Estimating Kohl's Optimal Capital Structure (figures shown in millions, except stock price and EPS)% firm financed with debt (wd)
0% 20% 30% 40% 50% 60% 70% 80% 90%
Weight of equity (ws)
100% 80% 70% 60% 50% 40% 30% 20% 10%
Cost of debt (rd)
5.63% 6.30% 6.70% 7.00% 7.50% 8.00% 8.50% 9.00% 10.00%
Beta (b) 0.58 0.67 0.74 0.82 0.95 1.13 1.44 2.05 3.88
Cost of equity (rs)
8.27% 8.87% 9.29% 9.86% 10.65% 11.84% 13.83% 17.80% 29.71%
Cost of debt (rd*(1-t)
0.63 0.63 0.63 0.63 0.63 0.63 0.63 0.63 0.63
WACC 8.27% 7.89% 7.77% 7.68% 7.70% 7.77% 7.91% 8.11% 8.66%
Value of Operations (vop)
4,607 4,830 4,901 4,958 4,950 4,903 4,817 4,698 4,400
Debt - 966 1,470 1,983 2,475 2,942 3,372 3,758 3,960
Equity 4,607 3,864 3,431 2,975 2,475 1,961 1,445 940 440
# Shares 222 178 155 133 111 89 67 44 22
Stock price 20.75 21.75 22.07 22.33 22.30 22.08 21.70 21.16 19.82
Net income 1,890.00 1,851.54 1,827.74 1,802.26 1,772.68 1,741.27 1,708.86 1,676.24 1,639.74
EPS 8.514 10.42 11.76 13.53 15.97 19.61 25.65 37.75 73.85
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10.2 How to Fund Acquisition
The acquisition of another company poses a very unique and often difficult to answer
question – how is the acquisition going to be funded? The transaction is not a simple charge card
or cash transaction. The method for which an acquisition is financed is based on many factors
including the prospective target company, the debt and equity already on the books for the
acquiring company, and the ability to obtain reasonable financing in the marketplace either via
debt or equity. “Each type of transaction will have its unique set of evaluation criteria, cost of
capital, expectations, deal terms, and covenants.” (Brown, 2011).
Kohl’s currently has $537 million in cash and cash equivalents on their current year SEC
10-K report. While that is a sizable chunk of cash for the organization to have on hand, it is only
a fraction of the value of J.C. Penney and would not be fiscally sound to drain the cash account
for such a situation. Different forms of financing should be examined to determine the best fit
for the operational growth and financial stability of the Kohl’s corporation.
As previously explained, Kohl’s’ has roughly $6.67 billion in adjusted debt (with $4.55
billion in long term debt) and $6.04 billion in equity as of the fiscal year 2012 SEC 10-K. As
with any situation, the combinations of debt and equity financings are numerous. With the debt
to equity ratio at 75%, Kohl’s still has the ability to take on more debt and maintain a debt to
equity ratio well below its competitors. However, their ability to find reasonable bank financing
could be greatly limited by the underperforming target acquisition. While the goal of the
acquisition is to turn J.C. Penney’s around into a profitable organization, banks may not be
willing to offer the financial assistance Kohl’s would need without a steep interest rate or heavy
debt covenants attached. A hefty interest rate on bank financing could dramatically affect the
cost of debt for the overall organization thereby increasing their cost of capital.
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A secondary form of funding is equity based. As mentioned above, Kohl’s has been
steadily repurchasing shares of their common stock. As of their 2012 fiscal year 10-K, they had
$7.2 billion in value of treasury stock. The amount of treasury stock Kohl’s has is well above the
necessary amount of capital needed to purchase J.C. Penney’s. However, as previously
mentioned, reselling the common stock could transfer the decision making abilities of the
organization over to a majority stakeholder should a stakeholder purchase enough treasury stock
to push their ownership percentage into the majority.
Kohl’s does not currently have any preferred stock. Preferred stock would be a
third viable option for obtaining capital for the purchase of J.C. Penney. If Kohl’s were
concerned about the possibility of losing decision-making capabilities as a result of the resale of
treasury stock, they could look into offering preferred stock. Kohl’s has been issuing dividends
since 2011 and could restrict the preferred stock capabilities to meet its needs. Since preferred
stock is higher in price, the company would not need to sell as much to obtain a sizable chunk of
the capital needed for the acquisition.
Finding the perfect balance of financing for the acquisition is an art form. As
Ronald A. Kahn mentioned, “Going to a broader audience is really key to getting the acquisition
deal done and at the best price” (Brown, 2011). With the overall optimal capital structure equal
to 40% debt and 60% equity, it is in the best interest of Kohl’s to sell some of its treasury stock
to obtain the vast majority of the acquisition price tag in order to limit the amount of debt it takes
on in addition to existing obligations. The remainder of the acquisition costs would then be
financed through untapped financial resources or through financing from a bank and private
investors.
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10.3 Growth Plan
When Kohl’s makes the acquisition of JC Penny, their growth projection can begin.
There are many ways that Kohl’s will benefit with this acquisition. The first one is the
consolidation of their operations throughout the United States and the business that JC Penny
does on their online store. In recent years Kohl’s has started to develop their marketing plans to
expand their clientele across the nation and online. The acquisition of JC Penny is a great growth
initiative for Kohl’s because JC Penny currently ships to over 50 countries around the world.
This allows Kohl’s to reach a wider more diverse market.
It adds over 1,100 stores to the Kohl’s family thereby doubling the quantity of stores for
the company. With the doubling of size, Kohl’s has the opportunity to keep the stores and build
their brand, sell the assets for liquidity, or subletting stores that are not necessary to produce cash
flow. It adds to the distribution centers to provide faster more efficient services to their clients.
Another great plus for Kohl’s is that JC Penny has over two thousand suppliers and does not
depend on any of them exclusively, making their items more affordable and their distributions
more reliable.
Another great opportunity with this acquisition is the diversity of departments that are
leased within its stores; this is a new opportunity since Kohl’s has not adopted this idea. JC
Penny has a diversity of departments including their optical centers and the portrait studios.
Kohl’s would also acquire the exclusive brands that JC Penny currently has and the marketing
initiatives including the “Mini Martha Steward Shops” as well as their spokes persons and new
pricing methods. In turn Kohl’s would implement their shopping strategies in the JC Penny
stores to make it a more enjoyable experience. It would also raise the standard of the public
perception and increase the positive feel towards the company.
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12 APPENDIX
12.1 Appendix 1
12.1.1 Industry Overview Sales per square foot
Sales per Sqft
Kohl'sNordstrom'sMacy'sDillard'sJC Penny's
(Kohl’s Corporation, 2013a)
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12.1.2 Kohl’s Income Statements for the past 3 years
Currency inMillions of US Dollars As of:
Jan 302010Restated
Jan 292011Restated
Jan 282012Restated
Feb 022013
Revenues 17,178.0
18,391.0
18,804.0
19,279.0
TOTAL REVENUES 17,178.0
18,391.0
18,804.0
19,279.0
Cost of Goods Sold 10,680.0
11,359.0
11,625.0
12,289.0
GROSS PROFIT 6,498.0 7,032.0 7,179.0 6,990.0
Selling General & Admin Expenses, Total 3,951.0 4,190.0 4,243.0 4,267.0
Depreciation & Amortization, Total 688.0 750.0 778.0 833.0
OTHER OPERATING EXPENSES, TOTAL 4,639.0 4,940.0 5,021.0 5,100.0
OPERATING INCOME 1,859.0 2,092.0 2,158.0 1,890.0
Interest Expense -311.0 -304.0 -299.0 -329.0
Interest and Investment Income 10.0 -- -- --
EBT, INCLUDING UNUSUAL ITEMS 1,558.0 1,788.0 1,859.0 1,561.0
Income Tax Expense 585.0 668.0 692.0 575.0
Earnings from Continuing Operations 973.0 1,120.0 1,167.0 986.0
NET INCOME 973.0 1,120.0 1,167.0 986.0
NET INCOME TO COMMON INCLUDING EXTRA ITEMS 973.0 1,120.0 1,167.0 986.0
NET INCOME TO COMMON 973.0 1,120.0 1,167.0 986.0
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EXCLUDING EXTRA ITEMS(Business Week, 2013)
12.1.3 J.C. Penney’s Income Statements for the past 3 years
Period Ending Feb 1, 2013 Jan 27, 2012 Jan 28, 2011
Total Revenue 12,985,000 17,260,000 17,759,000
Cost of Revenue 8,919,000 11,042,000 10,799,000
Gross Profit 4,066,000 6,218,000 6,960,000
Operating Expenses
Research Development - - -
Selling General and Administrative 4,535,000 5,251,000 5,585,000
Non Recurring 298,000 451,000 32,000
Others 543,000 518,000 511,000
Total Operating Expenses - - - Operating Income or Loss (1,310,000) (2,000) 832,000
Income from Continuing OperationsTotal Other Income/Expenses Net - - (20,000)Earnings Before Interest And Taxes (1,310,000) (2,000) 812,000 Interest Expense 226,000 227,000 231,000 Income Before Tax (1,536,000) (229,000) 581,000 Income Tax Expense (551,000) (77,000) 203,000 Minority Interest - - - Net Income From Continuing Ops (985,000) (152,000) 378,000 Non-recurring EventsDiscontinued Operations - - 11,000 Extraordinary Items - - -
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Effect Of Accounting Changes - - - Other Items - - -
Net Income (985,000) (152,000) 389,000 Preferred Stock And Other Adjustments - - - Net Income Applicable To Common Shares (985,000) (152,000) 389,000 (Yahoo Financials, 2013b)
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12.1.4 Growth, Profitability, and Financial Rations for Kohl’s Corporation
Key Ratios -> Profitability
Profitability 2008-01 2009-01 2010-01 2011-01 2012-01 TTM
Tax Rate % 37.78 37.89 37.59 37.49 37.22 36.84
Net Margin % 6.58 5.4 5.77 6.06 6.21 5.11
Asset Turnover (Average) 1.68 1.5 1.4 1.38 1.36 1.38
Return on Assets % 11.06 8.08 8.09 8.34 8.44 7.04
Financial Leverage (Average) 1.73 1.68 1.68 1.67 2.17 2.48
Return on Equity % 18.52 13.78 13.58 13.96 15.98 15.71
Return on Invested Capital % 13.93 9.46 9.69 10.2 9.33 9.24
Liquidity/Financial Health 2008-01 2009-01 2010-01 2011-01 2012-01 Latest Qtr
Total Liabilities & Equity 100 100 100 100 100 100
Current Ratio 2.1 2.04 2.3 2.08 1.84 1.57
Quick Ratio 0.37 0.37 0.95 0.84 0.47 0.15
Financial Leverage 1.73 1.68 1.68 1.67 2.17 2.48
Key Ratios -> Efficiency Ratios
Efficiency 2008-01 2009-01 2010-01 2011-01 2012-01 TTM
Debt/Equity 0.34 0.3 0.26 0.21 0.64 0.73
Days Sales Outstanding
Days Inventory 94.98 99.86 97.78 95.74 97.88 103.17
Payables Period 30.89 30.32 35.36 37.37 37.61 38.09
Cash Conversion Cycle
Receivables Turnover
Inventory Turnover 3.84 3.66 3.73 3.81 3.73 3.54
Fixed Assets Turnover 2.78 2.43 2.45 2.58 2.33 2.17
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Key Ratios -> Financial Health
Balance Sheet Items (in %) 2008-01 2009-01 2010-01 2011-01 2012-01 Latest Qtr
Free Cash Flow/Net Income -0.28 0.78 1.58 0.82 1.04 0.49
Cash & Short-Term Investments 6.28 5.96 17.23 16.79 8.55 3.86
Accounts Receivable
Inventory 27.04 24.7 22.21 22.38 22.7 26.95
Other Current Assets 1.94 1.99 2.24 2.45 2.63 3.12
Total Current Assets 35.26 32.65 41.68 41.62 33.88 33.94
Net PP&E 61.65 61.62 53.33 53.49 63.18 63.8
Intangibles 2.08 1.85 1.55 1.42
Other Long-Term Assets 1.01 3.88 3.44 3.47 2.94 2.26
Total Assets 100 100 100 100 100 100
Accounts Payable 7.92 7.77 9.03 8.39 8.93 9.4
Short-Term Debt 0.12 0.15
Taxes Payable 1.4 0.94 2.12 2.09
Accrued Liabilities 7.56 7.16 7.61 7.57 2.31 5.99
Other Short-Term Liabilities 1.18 0.93 0.12 3.08 5.02 0.76
Total Current Liabilities 16.77 16.01 18.16 19.98 18.38 18.23
Long-Term Debt 19.43 18.11 15.19 17.92
Other Long-Term Liabilities 6.01 6.41 22.17 20.29 20.26 20.35
Total Liabilities 42.22 40.54 40.33 40.27 53.82 56.5
Total Stockholders' Equity 57.78 59.46 59.67 59.73 46.18 43.5(Morningstar.com, 2013c)
12.1.5 Kohl’s Valuation and Industry comparison
KSS Industry Avg S&P 500 KSS 5Y Avg*
Price/Earnings 12.5 21.5 16.8 13.5Price/Book 1.9 4.8 2.3 1.9Price/Sales 0.6 1.2 1.5 0.8
Price/Cash Flow 9.7 11.7 9.9 7.8Dividend Yield % 2.5 1.1 2.3 —
Data as of 05/16/2013, *Price/Cash Flow uses 3-year average. (Morningstar.com, 2013c)
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12.1.6 Growth Profitability and Financial Ratios for J.C. Penney
Profitability 2009-01 2010-01 2011-01 2012-01 2013-01 TTM
Tax Rate % 37.69 38.21 34.94
Net Margin % 3.09 1.43 2.19 -0.88 -7.59 -7.59
Asset Turnover (Average) 1.4 1.43 1.39 1.41 1.22 1.22
Return on Assets % 4.35 2.04 3.04 -1.24 -9.29 -9.29
Financial Leverage (Average) 2.89 2.63 2.39 2.85 3.08 3.11
Return on Equity % 12.08 5.62 7.6 -3.21 -27.43 -27.43
Return on Invested Capital % 5.24 1.11 2.85 -3.86 -17.04 -17.04
Key Ratios -> Financial Health
Balance Sheet Items (in %) 2009-01 2010-01 2011-01 2012-01 2013-01 Latest Qtr
Free Cash Flow/Net Income 0.33 3.88 0.24 -1.22 0.83 0.83Cash & Short-Term Investments 19.58 23.93 20.1 13.19 9.51 9.51
Accounts Receivable 2.93 3.14 2.56 3.62 0.58 0.58
Inventory 27.13 24.04 24.64 25.53 23.93 23.93
Other Current Assets 2.14 1.76 1.54 2.14 3.63 3.63
Total Current Assets 51.79 52.87 48.84 44.48 37.65 37.65
Net PP&E 44.68 42.58 40.11 45.31 54.73 54.73
Intangibles
Other Long-Term Assets 3.53 4.55 11.05 10.22 7.62 7.62
Total Assets 100 100 100 100 100 100
Accounts Payable 9.94 9.74 8.69 8.95 11.88 11.88
Short-Term Debt 3.12 2.02
Taxes Payable 0.97
Accrued Liabilities 13.32 3.82 9.09
Other Short-Term Liabilities 9.13 11.61 3.1 14.53 14.53
Total Current Liabilities 23.26 25.82 20.3 24.12 26.41 26.41
Long-Term Debt 29.18 23.84 23.76 25.13 30.22 30.22
Other Long-Term Liabilities 12.96 12.36 14.08 15.64 10.95 10.95
Total Liabilities 65.41 62.02 58.14 64.9 67.58 67.58
Total Stockholders' Equity 34.59 37.98 41.86 35.1 32.42 32.42
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Liquidity/Financial Health 2009-01 2010-01 2011-01 2012-01 2013-01 Latest Qtr
Total Liabilities & Equity 100 100 100 100 100 100
Current Ratio 2.23 2.05 2.41 1.84 1.43 1.67
Quick Ratio 0.97 1.05 1.12 0.7 0.38 0.21
Financial Leverage 2.89 2.63 2.39 2.85 3.08 3.11
Key Ratios -> Efficiency Ratios
Efficiency 2009-01 2010-01 2011-01 2012-01 2013-01 TTM
Debt/Equity 0.84 0.63 0.57 0.72 0.93 0.84
Days Sales Outstanding 7.72 3.66
Days Inventory 108.83 107.71 105.4 101.3 107.57 107.57
Payables Period 42.05 41.49 39.87 35.62 44.69 44.69
Cash Conversion Cycle 74.5 69.88
Receivables Turnover 47.28 99.75
Inventory Turnover 3.35 3.39 3.46 3.6 3.39 3.39
Fixed Assets Turnover 3.58 3.27 3.35 3.32 2.47 2.47(Morningstar.com, 2013a)
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12.1.7 Distribution Centers for Kohl’s Corporation
(Kohl's Corporation, 2013a)
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12.1.8 “Nine-Box Merchandising Grid”
(Kohl's Corporation, 2013d)
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12.1.9 J.C. Penney WACC
The CAPM equation is ri = rRF + bi (rM − rRF) = 2.47%+2.07*(11%-2.47%)=20.13%. rRF = Risk free rate 2.47% (pg 66 of 10K)Ba = Beta 2.07Rm = Expected market return 11%
J.C. Penney WACCWeighted Average Cost of Capital = WACC = E/V * Re + D/V * Rd * (1-Tc)WACC=(70%*20.13%)+(30%*6.9%)*(1-35.9%) = 15.42% ForecastedRe = cost of equity 20.13% 20.13%Rd = Cost of debt 6.9% 6.90%E – market value of the firm’s equity = $4,359m (19.88 market price @ 02/02/2013 * outstanding shares.219.3 shares issued and outstanding)
4,359
D = market value of the firm’s debt $2,868m 2,86
8
V = E + D $4,359+2,868 = $7,227 7,22
7 E/V = Percentage of financing that is equity = Target 70%D/V = percentage of financing that is debt = Target 30%Tc = 1-Corporate tax rate 1-35.9J.C. Penney WACC pre-merger 15.42%
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13 APPENDIX 2 FINANCIAL STATEMENTS
13.1 Kohl’s Income Statement
KOHL’S CORPORATION
CONSOLIDATED STATEMENTS OF INCOME(In Millions, Except per Share Data)
2012 2011 2010Net sales
$ 19,279 $ 18,804 $ 18,391 Cost of merchandise sold (exclusive of depreciation shown separately below)
12,289 11,625 11,359 Gross margin
6,990 7,179 7,032 Operating expenses:
Selling, general, and administrative4,267 4,243 4,190
Depreciation and amortization833 778 750
Operating income1,890 2,158 2,092
Interest expense, net329 299 304
Income before income taxes1,561 1,859 1,788
Provision for income taxes575 692 668
Net income$ 986 $ 1,167 $ 1,120
Net income per share: Basic
$ 4.19 $ 4.33 $ 3.69 Diluted
$ 4.17 $ 4.30 $ 3.66
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KOHL’S CORPORATIONCONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In Millions) 2012 2011 2010Net income
$ 986 $ 1,167 $ 1,120 Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on investments5 13 (1 )
Interest rate derivatives: Unrealized loss arising during period
— (30) — Reclassification adjustment for interest expense included in net income 3 1 —
Other comprehensive income (loss)8 (16) (1)
Comprehensive income$ 994 $ 1,151 $ 1,119
(Kohl’s Corporation, 2013a)
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13.2 Kohl’s Balance Sheet
KOHL’S CORPORATION
CONSOLIDATED BALANCE SHEETS(Dollars In Millions)
February 2,
2013 January 28,
2012Assets Current assets:
Cash and cash equivalents$ 537 $ 1,205
Merchandise inventories3,748 3,216
Deferred income taxes122 109
Other312 299
Total current assets4,719 4,829
Property and equipment, net8,872 8,905
Long-term investments53 153
Other assets261 261
Total assets$ 13,905 $ 14,148
Liabilities and Shareholders’ Equity Current liabilities:
Accounts payable$ 1,307 $ 1,233
Accrued liabilities986 1,147
Income taxes payable137 133
Current portion of capital lease and financing obligations105 94
Total current liabilities2,535 2,607
Long-term debt2,492 2,141
Capital lease and financing obligations1,956 2,009
Deferred income taxes362 423
Other long-term liabilities512 460
Shareholders’ equity: Common stock - 360 and 358 million shares issued
4 4 Paid-in capital 2,454 2,339
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Treasury stock, at cost, 138 and 111 million shares (7,243) (5,977)Accumulated other comprehensive loss (45) (53)Retained earnings
10,878 10,195 Total shareholders’ equity
6,048 6,508 Total liabilities and shareholders’ equity
$ 13,905 $ 14,148
(Kohl’s Corporation, 2013a)
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13.3 Kohl’s Statement of Cash Flows
KOHL’S CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS(In Millions)
2012 2011 2010Operating activities Net income $ 986
$ 1,167
$ 1,120
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 833
778
750
Share-based compensation 50
57
66
Excess tax benefits from share-based compensation
(4)
(2 )
(3)
Deferred income taxes (79)
144
39
Other non-cash revenues and expenses
29
39
36
Changes in operating assets and liabilities:
Merchandise inventories (523) (160) (107)Other current and long-term assets
(37)
(42)
(50)
Accounts payable 74
96
(50)
Accrued and other long-term liabilities
(60)
63
12
Income taxes (4) (1 ) (63)Net cash provided by operating activities 1,265
2,139
1,750
Investing activities Acquisition of property and equipment (785) (927) (801)Sales of investments in auction rate securities
109
145
42
Other 16
(20)
2
Net cash used in investing activities (660) (802) (757)Financing activities Treasury stock purchases (1,293) (2,311) (1,004)Dividends paid (300)
(271)
—
Proceeds from issuance of debt 350
646
—
Deferred financing costs (3)
(8 )
—
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Interest rate hedge payment —
(48)
—
Long-term debt payments —
(400)
—
Proceeds from financing obligations 12
14
27
Capital lease and financing obligation payments
(111)
(91)
(84)
Proceeds from stock option exercises 68
58
75
Excess tax benefits from share-based compensation
4
2
3
Net cash used in financing activities (1,273) (2,409) (983)Net decrease in cash and cash equivalents (668)
(1,072)
10
Cash and cash equivalents at beginning of period
1,205
2,277
2,267
Cash and cash equivalents at end of period $ 537
$ 1,205
$ 2,277
Supplemental information: Interest paid, net of capitalized interest $ 318 $ 297 $ 304 Income taxes paid 654
550
689
Non-Cash Investing and Financing Activities
Property and equipment acquired $ 63
$ 79
$ 107
(Kohl’s Corporation, 2013a)
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13.4 J.C. Penney Income Statement
J.C. PENNEY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per share data) 2012 2011 2010Total net sales $ 12,985 $ 17,260 $ 17,759 Cost of goods sold 8,919 11,042 10,799
Gross margin 4,066 6,218 6,960 Operating expenses/(income):
Selling, general and administrative (SG&A) 4,506 5,109 5,358 Pension 353 121 255 Depreciation and amortization 543 518 511 Real estate and other, net (324) 21 (28) Restructuring and management transition 298 451 32
Total operating expenses 5,376 6,220 6,128 Operating income/(loss) (1,310) (2) 832
Net interest expense 226 227 231 Bond premiums and amortized costs - - 20
Income/(loss) from continuing operations before income taxes (1,536) (229) 581 Income tax expense/(benefit) (551) (77) 203
Income/(loss) from continuing operations $ (985) $ (152) $ 378 Income from discontinued operations, net of income tax expense of
$-, $- and $4, respectively - - 11 Net income/(loss) (985) (152) 389
Basic earnings/(loss) per share:
Continuing operations $ (4.49) $ (0.70) $ 1.60 Discontinued operations - - 0.04
Net income/(loss) $ (4.49) $ (0.70) $ 1.64
Diluted earnings/(loss) per share: Continuing operations $ (4.49) $ (0.70) $ 1.59 Discontinued operations - - 0.04
Net income/(loss) $ (4.49) $ (0.70) $ 1.63 Weighted average shares – basic 219.2 217.4 236.4 Weighted average shares – diluted 219.2 217.4 238.0
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J.C. PENNEY CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME/(LOSS)
($ in millions) 2012 2011 2010Net income/(loss) $ (985) $ (152) $ 389 Other comprehensive income/(loss), net of tax
Real estate investment trusts (REITs) Unrealized gain/(loss) on REITs 36 53 49 Reclassification adjustment for (gain)/loss on REITs included
in net income/(loss) (184) - -Retirement benefit plans
Net actuarial gain/(loss) arising during the period 37 (534) 236 Prior service credit/(cost) arising during the period (26) (3) -Reclassification of net prior service (credit)/cost recognized in
net income/(loss) from a curtailment (3) 1 -Reclassification of net actuarial (gain)/loss recognized in net
periodic benefit expense/(income) from a settlement 91 - -Reclassification for amortization of net actuarial (gain)/loss
included in net periodic benefit expense/(income) 148 94 155 Reclassification for amortization of prior service (credit)/cost
included in net periodic benefit expense/(income) (8) (15) (15) Total other comprehensive income/(loss), net of tax 91 (404) 425 Total comprehensive income/(loss), net of tax(J. C. Penney, 2013b)
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13.5 J.C. Penney Balance Sheet
J.C. PENNEY CORPORATION
CONSOLIDATED BALANCE SHEETS
($ in millions, except per share data) 2010 2009 Assets Current assets
Cash in banks and in transit $ 169 $ 163 Cash short-term investments 2,453 2,848
Cash and cash equivalents 2,622 3,011 Merchandise inventory 3,213 3,024 Income taxes receivable 334 395 Prepaid expenses and other 201 222
Total current assets 6,370 6,652 Property and equipment, net 5,231 5,357 Prepaid pension 763 - Other assets 678 572
Total Assets $ 13,042 $
12,581
Liabilities and Stockholders’ Equity Current liabilities
Merchandise accounts payable $ 1,133 $ 1,226 Other accounts payable and accrued expenses 1,514 1,630 Current maturities of long-term debt - 393
Total current liabilities 2,647 3,249 Long-term debt 3,099 2,999 Deferred taxes 1,192 817 Other liabilities 644 738
Total Liabilities 7,582 7,803
Stockholders’ Equity Common stock(1) 118 118 Additional paid-in capital 3,925 3,867 Reinvested earnings 2,222 2,023 Accumulated other comprehensive (loss) (805) (1,230)
Total Stockholders’ Equity 5,460 4,778
Total Liabilities and Stockholders’ Equity $ 13,042 $ 12,581 (J. C. Penney, 2013b)
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13.6 J.C. Penny Statement of Cash Flows
J.C. PENNEY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
($ in millions) 2012 2011 2010Cash flows from operating activities
Net income/(loss) $ (985) $ (152) $ 389 (Income) from discontinued operations - - (11) Adjustments to reconcile net income/(loss) to net cash provided by/(used in) operating activities:
Restructuring and management transition 121 314 24 Asset impairments and other charges 117 67 8 Net gain on sale or redemption of non-operating assets (397) (6) (8) Depreciation and amortization 543 518 511 Benefit plans 272 55 197 Pension contribution - - (392) Stock-based compensation 50 46 53 Excess tax benefits from stock-based compensation (12) (10) (2) Deferred taxes (467) (153) 126 Change in cash from:
Inventory 575 297 (189) Prepaid expenses and other assets (5) (67) 27 Merchandise accounts payable 140 (111) (93) Current income taxes 117 (15) 33 Accrued expenses and other (79) 37 (81)
Net cash provided by/(used in) operating activities (10) 820 592 Cash flows from investing activities
Capital expenditures (810) (634) (499) Proceeds from sale or redemption of non-operating assets 526 - -Acquisition (9) (268) -Proceeds from sale of operating assets - 15 14 Cost investment, net - (36) Proceeds from joint venture cash distribution - 53 -
Net cash provided by/(used in) investing activities (293) (870) (485) Cash flows from financing activities
Proceeds from issuance of long-term debt - - 392 Payments of capital leases and note payable (20) - -Payments of long-term debt (230) - (693) Financing costs (4) (20) (14) Dividends paid, common (86) (178) (189) Stock repurchase program - (900) -Proceeds from issuance of stock warrant - 50 -Proceeds from stock options exercised 71 18 8 Excess tax benefits from stock-based compensation 12 10 2 Tax withholding payments for vested restricted stock (17) (45) (2)
Net cash provided by/(used in) financing activities (274) (1,065) (496) Net increase/(decrease) in cash and cash equivalents (577) (1,115) (389) Cash and cash equivalents at beginning of period 1,507 2,622 3,011
Cash and cash equivalents at end of period $ 930 $ 1,507 $ 2,622
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(J. C. Penney, 2013b)
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