On August 12th, JC Penney reported results for the second quarter. The company lost $0.02 per share compared with a loss of $0.05 in last year's quarter. Analysts had expected a loss of around $0.05 per share. JC Penney's department store and catalog divisions performed very well. Comparable department store sales increased 2.1% while operating profit more than doubled to $51 million from $22 million last year. Catalog/internet sales increased 3.9 percent, representing the first quarterly sales gain in three years.

Conversely, results at JC Penney's Eckerd drugstore division were clearly disappointing. Operating income for the quarter declined 26 percent to $54 million compared with $73 million last year. Profit margins declined by 60 basis points while comparable store sales decreased 0.8 percent. Management believes that the decreases in sales and margins are a result of increased competitor store openings, particularly in Florida and Texas coupled with execution issues. We believe the recent deteriorating results at Eckerd could prove to be a catalyst for the company by either prompting a change in management or bringing about an outright sale of the company.

JC Penney shares have appreciated 20 percent since our original recommendation in May. We believe the sum of the department store and Eckerd drugstore divisions is likely worth between $26-$28 per share, representing a further 30 to 40 percent appreciation from the current share price. In addition, JC Penney still trades below its book value of $22.65 a share. Performance at the department stores should remain strong in the third quarter. Other department store companies have already reported strong sales in many back-to-school categories, an area in which JC Penney has traditionally been very strong. It should also be noted that child tax credits are now arriving in the mail with some families receiving as much as $400 per child.

December 5, 2003

JC Penney's third quarter results continued to trend as they did in the second quarter. Results at the department store and catalog/internet division performed well with operating profit up 22% to $207 million compared with $170 million in last year's period. These results were driven by strong back to school sales and a 190 basis point improvement in gross margin. Conversely, results at Eckerds continue to disappoint. Operating profit fell 57% to $34 million from $79 million last year. The drugstore chain continues to be hurt by poor execution and strong competition in the Texas and Florida markets.

JC Penney shares have appreciated nearly 40% since its second quarter results last August. We believe that much of what has driven this rally is speculation by the investment community that JC Penney is preparing to sell the struggling Eckerds drug store chain by the end of the year. Recent articles in both the Wall Street Journal and the Financial Times appear to confirm these rumours. Both newspapers, citing sources familiar with the situation, are reporting that a number of interested parties have already submitted bids for the Eckerds assets.

We believe that news of an Eckerds sale will be positive for JC Penney shares. First of all, with Eckerds out of the picture, JC Penney will once again be a pure department store play. As a result, its shares could command a higher price earnings multiple than its present valuation as a holding company. Second, with the proceeds from a sale, JC Penney would be able to substantially reduce its long term debt. This would give JC Penney a stronger balance sheet and would likely result in a better credit rating. Finally, in the event of a sale, we expect that JC Penney would generate a greater amount of free cash flow. This increase in free cash flow might be used to increase JC Penney's dividend, which now stands at $0.50 per share, or even fund a share buyback.

February 13, 2004

JC Penney reported that same store sales rose 6.4% in January. This growth rate exceeded the company's expectations. The increase reflected early success in spring apparel as well as the successful clearance of seasonal merchandise. Catalog and Internet sales increased 9.8%, which was also above plan. It is interesting to note that JCPenney.com has now become one of the largest apparel and home furnishing sites on the Internet with 2003 sales exceeding $600 million.

As we move into JC Penney's 2004 fiscal year, it is becoming clear that the company is getting closer to selling its struggling Eckerds division. On January 30th, JC Penney officially announced that it has provided substantial information to interested parties and that discussions are currently talking place. Further, on February 6th, the Wall Street Journal reported that JC Penney has received at least two bids for the drugstore division. CVS Corp, a U.S. drugstore chain, and Quebec based Jean Coutu Group have apparently both made offers for the Eckerds. The offering price is said to be in the range of $4 to $5 billion or between $14.65 and $18.31 per JC Penney share.

We continue to believe that selling Eckerd would be positive for JC Penney shareholders. Without Eckerds, JC Penney would once again become a pure department store play and its shares could command a higher multiple. Also, with the proceeds from the sale, JC Penney could pay off all of its long term debt and use the excess cash to fund a share repurchase and/or a possible dividend increase.

February 27, 2004

We purchased JC Penney in August 2003, with an initial target of $25 a share. At this time, we felt that we were buying the JC Penney department stores and essentially getting its Eckerds drugstore chain for free. When it became evident that JC Penney was in fact planning to sell Eckerds, we moved our target on the stock to $30.

With shares of JC Penney currently trading above $30, our primary target has now been met. However, while we originally purchased JC Penney as a deep discount investment, the shares appear to have entered a momentum phase at this time. We believe this is due to the company's recently announced better than expected fourth quarter results and that a sale of Eckerds appears to be imminent.

Although we see further upside potential in JC Penney shares, the company is no longer a deep discount investment. Therefore, we have chosen to be prudent and have sold half of our position in the company. It is important to remember that no definitive agreement has been reached pertaining to the sale of Eckerds. Should JC Penney decide not to sell Eckerds or should the sale occur at too low a price, the shares could come under pressure and fall back to the mid $20 level.

March 5, 2004

On February 27th 2004, we reported that we had sold half of our position in JC Penney. Although shares of the retailer had reached our target of $30, we felt that the stock had momentum. This week the stock rose a further 7-8% and with this appreciation we believe the stock is no longer fundamentally undervalued. With a good earnings announcement and the pending sale of Eckerds, the shares have mostly factored in all the positives. As a result, we decided to sell the remainder of our shares. We believe it is prudent at this time to take our profits and reinvest the proceeds in new and undiscovered deep value stocks.