I was asked by several commenters in my article "Reviewing The Sears Risk Of Insolvency Using The Altman Z-Score" to do the same exercise for J.C. Penney (NYSE:JCP). This article is the result.
I will be using the Altman Z-Score, along with other considerations regarding J.C. Penney's financials, to establish what kind of risk of insolvency it might be exposed to. As with Sears, one should take into account that the heavy short interest in the name can quickly lead to powerful short squeezes, especially if the stock gets any inkling of good news.
The Altman Z-Score is defined by Wikipedia like this:
The Z-score formula for predicting bankruptcy was published in 1968 by Edward I. Altman, who was, at the time, an Assistant Professor of Finance at New York University. The formula may be used to predict the probability that a firm will go into bankruptcy within two years. Z-scores are used to predict corporate defaults and an easy-to-calculate control measure for the financial distress status of companies in academic studies. The Z-score uses multiple corporate income and balance sheet values to measure the financial health of a company.
The Z-score is a linear combination of four or five common business ratios, weighted by coefficients. The coefficients were estimated by identifying a set of firms which had declared bankruptcy and then collecting a matched sample of firms which had survived, with matching by industry and approximate size (assets).
The Z-score has 5 inputs:
- T1 = Working Capital / Total Assets.
- T2 = Retained Earnings / Total Assets.
- T3 = Earnings Before Interest and Taxes / Total Assets.
- T4 = Market Value of Equity / Book Value of Total Liabilities.
- T5 = Sales / Total Assets.
The inputs show above then come together using the following formula:
Z = 1.2T1 + 1.4T2 + 3.3T3 + 0.6T4 + .999T5
Calculation for J.C.Penney
- Current assets: $3932 million.
- Current liabilities: $3648 million.
- Total assets: $10372 million.
- Retained earnings: -$1086 million (includes reinvested earnings).
- EBIT: - $1200 million (this includes the removal of $72+$298 million in restructuring charges)
- Market capitalization: $4170 million.
- Total liabilities: $7506 million.
- Revenues: $12468 million.
Using this data we get the following parcels:
- 1.2 * T1 = 0.033
- 1.4 * T2 = -0.147
- 3.3 * T3 = -0.382
- 0.6 * T4 = 0.333
- 0.999 * T5 = 1.201
This gives us an Altman Z-score of 1.04.
Interpretation and Conclusion
The Altman Z-score is interpreted according to the following ranges (source: Creditworthy.com):
3.0 or more,
Most likely safe based on the financial data. Of course, mismanagement, fraud, economic downturns, and other factors may cause an unexpected reversal.
2.7 to 3.0,
Probably safe to predict survival, but this is a portion of the gray area and is below the threshold of relative safety.
1.8 to 2.7
Likely to be bankrupt within two years. This is the lower portion of the gray area and dramatic action may be required to effect survival.
Highly likely headed for bankruptcy. Rarely would a firm be expected to recover from a financial condition generating this or lower scores.
Put simply, J.C. Penney is, according to the Altman Z-Score, headed towards bankruptcy. It's in quite worse shape than Sears, and has been experiencing much stronger revenue losses.
Going through the parcels, the main difference is that its retained earnings are already substantially negative, and its EBIT loss is also quite a bit deeper than Sears, no doubt because of the heavy revenue losses.
J.C. Penney's cash burn in 2012 was helped by a one-off inventory reduction, but unless there's some turnaround in its revenue growth rate (-16.4% year-on-year on Q1 2013) there doesn't seem to be much hope for shareholders.
JCP still has quite a bit of positive equity (whereas Sears already shows negative tangible book value) but still it doesn't make much sense to have the stock trade at a premium to that equity (it trades at a price/book value of 1.5).
Earnings estimates continue to plunge quickly, showing that JCP's prospects are still getting worse. All in all, the equity seems incredibly risky at the levels ($18.98) it trades at.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.