J.C.Penney: A Better Risk Reward At $8 Than $6

Dec. 6.13 | About: J.C. Penney (JCP)

When I first started posting on JCP, my thesis was rather simple. The stock was massively oversold from the ill-fated offering that bagged big holders, and the Company has almost a billion in fresh capital to get it through the next two years worth of holiday seasons. The offering bought time that would give the Company a chance to recapture about half of the sales Ron Johnson lost and with a return to private label and merchandise more suited to their core customer that the Company could at least get to the mid 30s in gross margin and maybe back to their old high 30s gross margins. What I didn't have confidence in was management's ability in the near term to stabilize the top line. The Company had been comping negative for two years and was in a virtual sales free fall. Ullman had just been rehired and the Company looked like a mess that could take a long time to fix. The Company was still burning cash as well.

Since the time after the offering, we know that the Company is finally comping positive and at a 29% gross margin which is not bad considering they are clearing out some of the Johnson era inventory at steep losses. December comp sales were up 10% which was the best result in five years for the Company. My initial fear was that the holiday season would be such a disaster that we either wouldn't get to the next holiday season or would be massively diluted in order to get there. After Q3 and November results, I no longer fear those downside scenarios. Christmas will likely be a non-event to modestly positive as the Company is beating expectations. I now have more confidence that the Company can get to a $15 billion sales target. Run rate SGA is only $4 billion and the Company is confident that number can be lower since it was built around a $19 billion top line. A return to $15 billion in top line now yields closer $2 billion in EBITDA to a mid $20s stock price at 6x multiple.

More important to the equity story is the time the Company now has to execute a turnaround. JCP cut capital spending to $300 million for 2014, which was well below my initial numbers. The cuts in SGA and CapX have dramatic effects on my model. Two months ago, I was modeling about an $800 million burn for next year. Now with a mid-single digit increase in sales to about $12.7 billion, a 36% gross margin, $4 billion of SGA and only $300 million of CapX and $365 million of interest, I project burn at just under $100 million. Given JCP's ample liquidity, this change means that shareholders no longer need to fear further dilution and that the Company should have virtually unlimited amounts of time to get back the sales and margins that were lost. The stock has always represented a call option on a turnaround, but now the expiration date has been pushed out to forever as long as sales stabilize just under $13 billion. We also know that the CEO has recently bought about $1 million of stock (a year's base salary) at $8.87.

While the stock is well off its lows, it has been hit for the last three days on a combination of momentum investors who chased the stock to the high $10s selling as the stock declined, news that Kyle Bass has sold his common (although he has kept his bonds), and now news that the Company is being investigated by the SEC for its stock offering. You can now buy the stock well below where Myron Ullman bought and the $9.6 stock offering. The SEC investigation is not news. The offering was botched and lawsuits and investigations are par for the course for turnaround stories in America. I would have been surprised if there wasn't some kind of suit or investigation. At the current $8.20 price, you get to invest with much greater certainty that A) Further dilution is most likely off the table, B) The Company can achieve positive comp. sales growth. C) The Company with stabilization has a shot to build back EBITDA and free cash flow to create some serious equity value. None of that was clear the last time the stock was here and at $6 with the CDS and bond yields blowing out to near Chapter 11, things looked downright scary. So even though the stock is still up a ton of the lows, it represents a better buy here because you have much greater certainty to long-term value creation. I believe it is one of the best buys in the market right here and now.

Disclosure: I am long JCP. 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.

Additional disclosure: Positions can and do change without warning or notice.