Memo to Wall Street: Out here on Main Street, we love our sales.

The hedge-fund managers now calling the shots at J.C. Penney (JCP) learned this the hard way, when sales totals at the old-line retailer dropped a painful 20% in the first quarter -- largely because they yanked coupons and most sales away from shoppers.

The stock tanked, and last week Penney started backtracking. It plans to add more sales, though, so far, not coupons.

The wizards behind Penney's ongoing makeover may wise up over time. But this is a terrible start.

And it means you have to wonder if J.C. Penney -- which dates back to 1902, when James Cash Penney opened his first store in Wyoming -- is doomed to follow the recent path of another iconic retailer.

That would be Sears, (SHLD) which is being run into the ground by hedge-fund manager Eddie Lampert of ESL Investments (see "Why Sears in on its last legs"). Sears, too, had seen better days before Lampert took over. But its history under Lampert has been one of failed plans and neglect, customer defections and store closings.

So will Penney's follow the same downward grind, or will the overhaul work?

image: Michael Brush

Michael Brush

As the turnaround turns

To some investors, Penney's may look tempting right now. The stock is down 40% this year from January highs above $43 to under $26. It remains a huge retail presence with a brand everyone knows and more than 1,000 stores nationwide.

And Penney management remains positive. Even as they announced dismal earnings, the Masters of the Universe in charge at Penney said their makeover was ahead of schedule.

Yet in the first quarter, store traffic fell 10% as shoppers thumbed their noses at all the recent improvements. If this is success, what's failure?

Despite the numbers, Bill Ackman, of the Pershing Square Capital hedge fund, which has a big enough stake to be on the board and call the shots, has maintained publicly that this could be a "10-bagger." That's a tenfold profit on the stock -- an enticing prediction.

For a deeper look into the J.C. Penney overhaul, I consulted two veteran retail-sector experts. One suggested a root problem: Hedge-fund masters just don't get regular shoppers or retailing. "Being wealthy doesn't necessarily link to being smart. This thing is going to be a bigger train wreck than Sears," said this former CEO at a major national retail chain, who now teaches at a top business school.

My own verdict: There's more bad news to come, and J.C. Penney may well be run into the ground just like Sears, unless the people in charge wise up in time. The stock might be a gamble worth taking, but only at an even lower price.

Here are five key questions -- with my answers -- about the road ahead for this American icon.

1. Are the people in charge all they're cracked up to be?

Warren Buffett famously says a key ingredient in a winning investment is top-rate management. Is that what we have here? The J.C. Penney bulls certainly want you to think so. Slide decks explaining the overhaul -- from Ackman and the company itself -- are laced with references to Apple (AAPL), photos of Apple stores and products, and even Steve Jobs.

This, of course, is meant to suggest that J.C. Penney CEO Don Johnson has a special retail management magic. He was in charge of setting up the highly successful Apple retail stores. But how much does Apple's success with stores really tell us about how successful Johnson will be at J.C. Penney?

Not one bit.

"If Apple products were sold from homeless shelters, there would still be lines outside the homeless shelters," says veteran retail-sector analyst Howard Davidowitz of Davidowitz & Associates, a retail consulting and investment banking firm. Johnson's success at Apple was all about the popularity of Apple products. "It has no relevance to J.C. Penney at all," says Davidowitz.

Likewise, Johnson's experience at Target during the 1990s -- another talking point used by Penney bulls -- may not be a great indicator of his skills. "Johnson was one of many executives at Target," says Davidowitz.

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One positive here: Johnson spent $50 million to buy the rights to purchase 7.3 million Penney shares at $29.92 after six years. That shows conviction.

As for Ackman, one of the hedge-fund bosses in command here, two previous attempts to "fix" retailers did not go so well. One, Borders Group, went bankrupt. And he had big plans to overhaul Target's (TGT) real-estate holdings a few years ago to push the stock up. That didn't work out, either.

Stocks mentioned in this article include: Talbots (TLB).

2. Is the new management doing too much, too fast?

You bet, and this is the problem. Major overhauls at retailers are tough. And the new bosses at J.C. Penney are changing a lot. Everything from product -- they're putting fewer choices on shelves and bringing in more upscale brands -- to pricing, store layouts, information management systems and staffing levels.

Major makeovers are even tougher when you try to do them quickly. "They are tearing apart the entire company all at once," says Davidowitz. "I'm not saying their ideas are wrong. I'm saying the way they are doing this will lead to a complete unraveling of the company. It's going to be a mess. It typically takes years to make all those changes."

But even at a slow pace, total retail makeovers can fail badly. Back in 2007, new managers tried to overhaul the retailer Talbots (TLB) with a plan quite similar to the one for J.C. Penney now, points out Charles Grom, an analyst with Deutsche Bank. Bad move. Talbots stock fell from about $25 in early 2007, to about $2.40 now.

3. Will JC Penney customers trek to the stores without coupons?

Maybe not. And this is a big issue.

Last fall, Penney boldly announced plans to ditch coupons and most sales in favor of regular, monthlong sales on some seasonal items and some Friday clearance sales. Everything else is offered at "Fair and Square Every Day" prices. So far, that has changed only slightly.

Two big problems here.

First, shoppers love their coupons. Macy's (M) learned this six years ago when it cut back on coupons after buying May Department Stores. It reversed the decision after sales fell sharply. Nowadays, coupons are even more important than back when the economy was booming. "We are living in a world where family income is down 10% in the last four years," says Davidowitz. Morgan Stanley surveys confirm that coupons were the top reason customers shopped at J.C. Penney.

Recent comments by Penney CEO Johnson that customers just need to be better educated about the new pricing policies sparked a backlash in the blogosphere. "To say coupon users need to be educated is absolutely insulting. . . . This executive needs a reality check," a shopper using the handle Rocketmom60 recently posted at one couponing site.

The second problem is the pricing concept. "Everyone who has attempted it has failed, because there is no way to position it empirically in a customer's mind," says the former CEO from a national retail chain, who asked not to be identified. "What does 'everyday fair pricing' mean?"

J.C. Penney is showing signs of wising up here. But it needs to move decisively, or competitors will continue to steal business.

4. Is heavy cost-cutting a good thing?

Apparently there's a lot of fat at J.C. Penney. Ackman says Netflix (NFLX) streaming video recently accounted for 20% of Penney home-office bandwidth use during work hours, and the typical employee clicked on YouTube videos 1,000 times a month.

Besides layoffs, the company has room to cut inventory and reduce spending on advertising and technology. Big cuts would highlight an inherent cost advantage -- Penney owns a lot of its real estate, and it has a lot of long-term, low-cost leases.

Ackman estimates that $900 million in cuts, the company's target, would equal $2.50 a share in earnings, or $30 a share at a price-to-earnings ratio of 12.

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The problem is that a lot of the cuts have already been made. And the stock is still sluggish.

Morgan Stanley analyst Michelle Clark may have a good explanation. She thinks the aggressive cost cuts are hurting sales. "The scale of changes being made concerns us," says Clark.

Stocks mentioned in this article include: J.C. Penney (JCP) and Sears (SHLD).

One big potential issue: Penney is cutting out "unproductive inventory" -- items that don't sell as much. This supposedly brings down costs by reducing the amount of money tied up in inventory, but it may be a terrible move. Even though less-popular items don't sell as much, they bring in loyal customers who buy lots of other stuff while they're in the store.

Wal-MartStores (WMT) reduced the number of items for sale in 2009 to "reduce clutter," the same logic Penney is using now. Wal-Mart has since returned a lot of these items to the aisles, because the change cut into shopping trips, hurting overall sales. "These big shots sitting in their offices, they want to have this clarity," says Davidowitz. "But how about the customer? The customer is everything."

5. Will creating a 'mall within a mall' really help?

Citing much higher sales per square foot at specialty stores compared with department stores, the new team at J.C. Penney is setting up a lot of "stores" inside Penney.

To show the potential here, Ackman and Penney managers like to cite the sales per square foot of over $600 at Penney's Sephora beauty product shops, compared with $154 a square foot at Penney overall.

Eventually, a Penney store could have 100 or more shops, like Martha Stewart and Michael Graves in home goods, or Watchgear by Tourneau Watches & Accessories.

This might help because Macy's, which uses this "mall within a mall" concept, has sales per square foot at $174, near the hoped-for target at Penney of $177. But it's not a lock. "Sephora is a success, but is strong enough to pull it off. Most brands are not," says the former retail chain CEO.

Buy below $23

J.C. Penney and Ackman declined to talk with me. But in news releases and comments to analysts, Penney says it offers great values and is changing for the better. The company says 2012 is the "transition year," and growth will follow in 2013.

Meantime, wait for further declines to buy. Goldman Sachs (GS) analyst Adrianne Shapira has a neutral rating on Penney. Deutsche Bank's Grom is waiting for clearer signs that the Penney overhaul is working. Morgan Stanley's Michelle Clark sees more downside risk, and she suggests considering a buy below $23.

"I think there is hope," says Davidowitz. "But Penney is going to have to slow down and re-strategize." My guess is they will, so I'll go with Clark's $23 as a buy limit.

Stocks mentioned in this article include: J.C. Penney (JCP), Sears (SHLD) and Apple (AAPL).

At the time of publication, Michael Brush did not own or control shares of any company mentioned in this column.

Michael Brush is the editor of Brush Up on Stocks, an investment newsletter. Click here to find Brush's most recent articles and blog posts.