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We are going to continue to look at J.C. Penney (JCP) and build off our work in our previous article where we projected a $266 million net loss for J.C. Penney in Q4 2013. In this article, we are going to take a closer look at J.C. Penney's sales trends and look at how J.C. Penney's financials will look under a couple different recovery scenarios.

Same Store Comps Vs. 2010

Using a two-year stack, Wells Fargo's Paul Lejuez also showed that J.C. Penney's +10.1% performance in November was primarily attributable to a very poor November 2012 rather than a big improvement from October to November. We are going to revisit comps again by comparing recent quarters and months to 2010.

2010 is a good year to compare with since it was a year with fairly stable sales (largely matched to J.C. Penney's expectations, although the 4th quarter came in fairly strong and thus is a tougher comp) and is the last full year before Ron Johnson took over. We looked at using 2011 as the base year also, but that year was less stable in terms of sales and was marked by significantly declining sales that fell well short of J.C. Penney's expectations towards the 2nd half of the year.

Looking at the below table we can see that J.C. Penney had stabilized at around -30% versus 2010 by December 2012, but has had trouble breaking free of that range since them. Even November 2013's +10.1% comps versus last year does not improve its comps versus 2010 beyond -29.9%. To be fair, November 2010 was probably the strongest month for J.C. Penney in 2010, so it represents a tougher comp. However, this method is a much more accurate way of assessing J.C. Penney's sales trends than trying to compare vs. last year where sales were tumbling month after month. In our projections we have given J.C. Penney the benefit of the doubt and assume that it can break free of the -30% range vs. 2010 that it has been stuck at for the past year.

Stacked Comps Vs. 2010

% Change

Q2 2012

-20.5%

Q3 2012

-27.3%

Q4 2012

-32.9%

Nov 2012

-36.3%

Dec 2012/Jan 2013

-31.0%

Q1 2013

-29.8%

Q2 2013

-30.0%

Q3 2013

-30.8%

Q4 2013

-29.1%

Nov 2013

-29.9%

Dec 2012/Jan 2013

-28.5%

Looking Ahead To The Future

Here's how J.C. Penney's financial situation will look with solid improvements in both sales and gross margin over the next few quarters. In this scenario, same store comps increase by 2% each quarter and gross margins increase to 37% by Q3 2014. While the +4.0% same store increase for Q1 2014 appears to be a slowdown from Q4 2013, it actually represents an improvement in comps vs. 2010 to -27.0% from Q4's -29.1%.

Despite showing near double-digit comps and 37% gross margins by Q3 2014 and minimizing capital expenditures, J.C. Penney would still be on track to burn $757 million versus its position at the end of Q3 2013. This would leave it with approximately $950 million in liquidity and $470 million in cash and cash equivalents (without additional borrowing), assuming that other working capital items at similar levels in Q3 2014 as they were at Q3 2013. This is a similar financial position to where J.C. Penney was when it issued additional equity in September 2013 and would result in a significant chance of additional dilution.

Q4 2013

Q1 2014

Q2 2014

Q3 2014

Total

Net Sales ($ Million)

$3,918

$2,732

$2,817

$3,009

$12,476

Same Store Comps

5.7%

4.0%

6.0%

8.0%

6.3%

Gross Margin ($ Million)

$1,175

$902

$986

$1,113

$4,176

Gross Margin %

30.0%

33.0%

35.0%

37.0%

33.5%

SG&A ($ Million)

$1,145

$1,000

$980

$1,020

$4,145

Capital Expenditures ($ Million)

$175

$75

$75

$75

$400

Net Interest Expense ($ Million)

$97

$97

$97

$97

$388

Cash Burn (Ex. Working Capital Changes) ($ Million)

-$242

-$270

-$166

-$79

-$757

A More Modest Recovery

In a slower recovery scenario for J.C. Penney (but nonetheless showing sustained improvements in both sales and gross margins), J.C. Penney may burn $942 million by Q3 2014 and still have cash burn of $168 million in Q3 2014 despite +5.0% same store comps and gross margin improvement to 35%.

In this scenario, same store comps increase by 1% each quarter, and gross margins increase to 35% by Q3 2014. The +3.0% same store increase for Q1 2014 still represents an improvement in comps vs. 2010 to -27.7% from Q4's -29.1%.

J.C Penney would have approximately $770 million in liquidity and $285 million in cash and cash equivalents (without additional borrowing), assuming that other working capital items at similar levels in Q3 2014 as they were at Q3 2013. With the continuing high rate of cash burn, J.C. Penney would be virtually guaranteed to need additional funds.

Q4 2013

Q1 2014

Q2 2014

Q3 2014

Total

Net Sales ($ Million)

$3,918

$2,706

$2,764

$2,925

$12,313

Same Store Comps

5.7%

3.0%

4.0%

5.0%

4.7%

Gross Margin ($ Million)

$1,175

$866

$926

$1,024

$3,991

Gross Margin %

30.0%

32.0%

33.5%

35.0%

32.4%

SG&A ($ Million)

$1,145

$1,000

$980

$1,020

$4,145

Capital Expenditures ($ Million)

$175

$75

$75

$75

$400

Net Interest Expense ($ Million)

$97

$97

$97

$97

$388

Cash Burn (Ex. Working Capital Changes) ($ Million)

-$242

-$306

-$226

-$168

-$942

Conclusion

The challenge for J.C. Penney is that we don't know yet if the signs of recovery it is showing will be sustained, and even if it is sustained, the pace of improvement may not be quick enough to avoid additional financing or dilution. Even with an improvement to +8% same store comps and 37% gross margin by Q3 2014, J.C. Penney is likely to seek additional funding. Any sales growth or margin recovery less than that virtually guarantees it. Thus even a recovery may come at a high cost to J.C. Penney.

Source: J.C. Penney: The High Cost Of Recovery