J.C. Penney: Good News Is Good News

Jan.16.14 | About: J.C. Penney (JCP)

The retail reporting season has been a horror show from everyone from Lululemon (NASDAQ:LULU) to Best Buy (NYSE:BBY). The shortened season, which drove excessive promotional behavior, combined with the still tepid economy and the frost, which closed malls, has crushed holiday sales. Even the rock solid auto retailers are finally missing numbers as consumers have taken advantage of zero percent interest rates to upgrade their aging fleet of cars (10-year average life) and now suddenly stopped. 'All is not right with the consumer' is a fair macro read from the season.

Into the valley of death rode J.C. Penney (NYSE:JCP), who had the unpardonable sin of actually making its guidance for the first time in years. The stock has been crushed to all-time lows (last seen in October when there was a legitimate liquidity scare and the bonds traded near 20% yields). Those bonds now trade at 10-12% yields, indicating that the bond market does not think JCP is going to file any time soon if ever. To be fair, after a 10% November comp, it looked as if JCP was going to blow away Q4 guidance and to merely meet or modestly beat guidance set the market up for a surprise and the market hates surprises. Now, the company is pruning about 3% of its store base, the worst performer in the retail Hunger Games and the market hates that too?! That said, look at the horror show of BBY, SHLD, AN, SSI - even LULU had negative comps. High end, low end, sports, electronics, auto - everyone missed. Everyone except JCP and Macy's (NYSE:M), whose modest comps increase and similar levels of store cuts to JCP has sent its stock to alltime highs. No one said that life should be fair, but the contrast is startling.

The Company is going to save $65 million annually from the closures. At 6x EBITDA, JCP just added $1.28 a share in value to the equity or a 20% increase in value. The Company has pruned its worst 3% performing stores that one analyst estimated were losing about $1mm each in EBITDA. These cuts are entirely consistent with getting the Company's cost base in line with a $12-15 billion retailer, not the $19 billion retailer that they used to be. More cuts and closures could be on the way which is good, not bad as the equity market seems to think. If the bond market thought this was bad, the bonds would be back to just under 20% yields and they haven't budged.

For the coming year, I am estimating that JCP will do about $12.5 billion in sales. After the cost cuts, SGA should be more like $3,935 billion and not the $4 billion I was estimating. At a 37% margin (the same as that perennial dog Bonton (NASDAQ:BONT)), the Company should generate about $682mm in EBITDA which covers the $300 million in CapX and $365 million in interest with a little free cash flow to spare. If this is the baseline going forward, JCP can muddle for a long time to get its sales back. The following year on basically the same expense base with a mid single digit increase in revenue, EBITDA rises to $1 billion and the year after that to just under $15 billion in revenue and $1.5 billion in EBITDA. 6x 1.5 billion of EBITDA is $18 a share in value but in this scenario, JCP generates about $3 per share in free cash flow, sop the value to the equity is more like $21+ per share, or a 47% IRR over 3 years from the current quote. Sometimes good news is just good news.

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 at any time without warning or notice.