After J.C. Penney's (JCP) earnings release last week the company has come under a lot of pressure, the day after the release it was down almost 13% to $17.97. There seems to be growing concern that the company might face a cash crisis and could have a going concern issue in 2013. In my view this seems to be a complete stretch, the company's liquidity is more than enough to handle 2013 and 2014 as well and if you look at the numbers rather than the rumors you can see that the numbers tell a different story.
This is an 8-K that the company filed with financial data for the last quarter; this is the balance sheet with the latest numbers:
You can see that the current assets are almost double as the current liabilities. The current asset section does include more illiquid stuff as their own inventory ($3.3B) but the company has a $1.5B credit line that they can use with the inventory as collateral, furthermore inventories can be monetized with promotions and discounts. That is not the strategy of the company but its certainly an option that any CFO will recommend should their cash come under pressure.
What seem to have gotten people worried is that their cash is now down to $500M, but what this misses is that this was the result of a debt payback, not from operating results (which the company is struggling with and the media attention is all over).
You can see that the operating results had a modest cash drain of $48M and most of the decrease in cash came from the retirement of long-term debt. The company could have easily offset that by drawing on the credit line or raising more debt capital but they decided to run down their cash a bit because year end sales are coming. This is what the bears on the stock are missing with regards to JCP liquidity, Q4 is likely to produce significant amounts of cash and put the company in solid footing for 2013
For instance here is JCP cash flow provided by operating activities by fiscal year end with how much operating cash was provided during Q4 (holiday season plus January)
Operating cash flows:
- +$1.573B for 2009 +$1.100B in Q4
- +$592M for 2010 +$1.100B in Q4
- +$820M for 2011 +$953M in Q4
Even if Q4 operating cash flow were to deteriorate a lot JCP is still expected to receive quite a bit of operating cash during Q4 (its shopping season after all). If we apply a conservative 50% mark down on the likely future Q4 cash flow, JCP should still receive about $500M in operating cash (roughly half of last year) helping it to reach its goal of $1B of cash and cash equivalents by year end. The total net operating cash flow for the whole year would end at modest -$155M (so much for the reports that the company is "bleeding cash" most retailers make their money at year end that's what they are missing)
The truth is that the company's liquidity can be easily dealt with given that the big drainer of its cash has been its own investments in their new store models (a store within a store). At any sign of liquidity problems the company could alter the speed of which they execute these investments and decrease the cash burn (there is a difference between cash burn and discretionary cash burn). They won't likely need to do that given that they have the line of credit plus they are also working on non-core asset sales.
$500M in cash + $2B in inventory ($1.5B tied to a credit line+rest that can be sold safely) +$500M in year end holiday sales operating cash flow + Real estate assets (both core and non-core) that can be monetized (on the books they are worth $5B+ but they are actually worth way more than that because GAAP keeps the value of those assets at cost and they are not marked to market) let's call it $1B = $4.5B in total liquidity (current liabilities are $2.7B)
It's likely all of these assets can be readily monetized in less than 12 months, the real estate assets are probably attractive to Simon Properties or to GGP and they wouldn't have a problem selling them quickly. This more than enough to pay off all the current liabilities of the company plus a buffer against cash burn.
The next significant debt maturity of the company only happens in October 2015 so this liquidity buffer is enough the handle problems till them. The company is probably even ok during a mild recession in this period (though they will likely have to draw on the credit line, sell real estate assets and perhaps slow down investments in new stores but they will survive, remember this terrible year will only ended likely having a cash burn from operations of less than $200M, year to date they are at around -$700M in cash burn with holiday sales around the corner, even a -$1B year can be handled by their liquidity and it would take a disaster to produce that).
The real estate assets that can be sold don't have to be just non-core assets they could sell core assets if things gotten really bad but its likely they won't need to go there. Even for next year if they were lose $200M again in cash from operations (unlikely due the rolling out of the new stores which are selling more) they would still be OK.
$1B starting cash -$200M operations -$900M capex = -$100M. This can easily be dealt with the credit line, selling some assets and slowing investments. Truth is the numbers show that the liquidity is fine and they have enough to fund the turnaround. The only question investors should be asking is, does this new model work?Does the "Ron Johnson Method" of running these shops work? Looking at the last earnings presentation you can see the results of the Ron Johnson Method:
You can see that his new shops model does increase the productivity in terms of sales per unit of space. What this means is that as they change the old store model to the new, they will have an instant boost in revenues as shoppers who appreciate the experience start to spend more. The company expects to go from 10 to 40 new stores next year, this will provide an additional source of revenues for the company and is likely to stabilize sales. The question is, why are they struggling right now? The answer is traffic and conversion:
You can see that traffic is off quite a bit but has reached some sort of stabilization level.
For the bear case to work the company will have to face a further decline in traffic and conversion which is unlikely given that traffic is flat even though the company ended its promotional activity called "Month Long Value", which was the main reason the company had bad earnings last quarter. To me the fact that the traffic stabilized even though they took off that promotion is a sign of strength here.
Conversion declined for the same reason, the end of that promotion hit their sales and this has given the impression to some stock holds that JCP is a "business in decline" when in fact it was the company's choice that is likely to be better in the long-run, absent another end of a promotional activity (which the company has not announced matter of fact they are preparing more for year end sales) conversion is unlikely to decline further (except in the mind of panicky investors extrapolating trends into infinity)
Since traffic is likely to have bottomed and should trend up gradually (the folks who hated the lack of coupons and discounts already stopped shopping, its old news and has more than played out in the stock already, proven by the fact that the end of month long value didn't drive traffic lower). It's common for stock investors to extrapolate things into the future and that's what seems to be happening here. People think sales and traffic will just go down forever but if you actually look at the numbers is looks likely that sales have bottomed.
If you are short you should ask yourself "what will happen to drive traffic lower?" because as bad as this year has been it will only drain $200M in cash from operations (factoring in conservative holiday sales cash flows) from the company, at this pace the company has years to go before they have issues and have to raise equity.
The combination of:
- New stores that are rolling out (the new model works and produces more revenues per unit of space) from 10 stores to 40 next year
- Operating efficiencies leading to decreased costs (company's goal is $900M in cost savings, they will probably miss this by $100M or so)
- Gradual pickup in JCP interest as the customer experience gets more well known, traffic is likely to rise (it would have risen had not been for the end of "Month Long Value")
- Standard growth in retail sales as US economic growth continues
Due these factors its very likely that will improve JCP operational results for next year. The boost from Q4 holiday season will likely both the bottom for the stock (cash will likely be boosted to over $1B) but also for the bearishness surrounding the company as it becomes clear that the new stores transformation will boost the revenues from the company, traffic has bottomed and will improve gradually and analysts realize their job is not to extrapolate trends ad infinitum and upgrade the stock. Barring a special insight that the US is headed towards a severe recession, JCP stock is a strong buy.
There is also the chance the stock could become a LBO target, its not something that I would want to happen as I believe management will deliver significant improvements but a large premium to the recent price is nothing to sneeze at either and its a risk to the shorts