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J.C. Penney (NYSE:JCP) announced that it was closing 33 underperforming stores yesterday. Although this is unwelcome news for the affected workers and towns, the decision does make sense financially for J.C. Penney. However, while this move is a step in the right direction, it is only a modest step that will have only an incremental effect on J.C. Penney's overall fortunes. Closing 200 or 300 stores would have the potential to significantly reshape J.C. Penney's recovery path. Closing 33 stores is a relative drop in the bucket. As a result, J.C. Penney's ability to avoid dilution will still require a strong recovery in gross margin and a quicker recovery in sales than it has demonstrated so far.

We estimate that J.C. Penney's liquidity position will improve by $50 million to $75 million by the end of 2014, and that net income will be positively affected by $10.95 million in 2014 and $33.32 million in 2015.

Store Closures

Below is the list of store closures along with the distance to the next nearest J.C. Penney store from the closing store. All of the stores except Cut Bank have alternative department or discount department stores nearby that will gain some of J.C. Penney's lost business. However, if the next nearest J.C. Penney store is close enough, that will retain some business from loyal J.C. Penney customers.

We are estimating that J.C. Penney will retain 90% of sales at stores with another J.C. Penney within 5 miles, 75% of sales at stores with another J.C. Penney within 5 to 9 miles and 50% of sales at stores with another J.C. Penney within 10 to 14 miles. This decreases to 30% at a distance of 15 to 19 miles, 20% at a distance of 20 to 29 miles, 10% at a distance of 30 to 49 miles and 0% at a distance of 50 miles or above. Since there appears to be no competitor stores near Cut Bank, we estimate that J.C. Penney will retain 25% of that store's sales despite the 92 mile distance to the next nearest J.C. Penney store.

Based on these calculations, we estimate that J.C. Penney will be able to retain 30% of sales from the closed locations.

State

City

Mall

Distance To Next J.C. Penney (Miles)

Nearby Alternatives

Sales Retained (%)

AL

Selma

Selma Mall

36

Y

10

CA

Rancho Cucamonga

Arrow Plaza

2

Y

90

CO

Colorado Springs

Chapel Hills Mall

6

Y

75

CT

Meriden

Meriden Square

11

Y

50

FL

Leesburg

Lake Square Mall

20

Y

20

FL

Port Richey

Gulf View Square

12

Y

50

IA

Muscatine

Muscatine Mall

25

Y

20

IL

Bloomingdale

Stratford Square Mall

8

Y

75

IL

Forsyth

Hickory Point Mall

35

Y

10

IN

Marion

Five Points Mall

24

Y

20

IN

Warsaw

Marketplace Shopping Center

28

Y

20

MD

Salisbury

The Centre at Salisbury

38

Y

10

MI

Marquette

Westwood Plaza

58

Y

0

MN

Worthington

Northland Mall

41

Y

10

MS

Gautier

Singing River Mall

20

Y

20

MS

Natchez

Natchez Mall

58

Y

0

MT

Cut Bank

N/A

92

N

25

NC

Kinston

Vernon Park Mall

20

Y

20

NJ

Burlington

Burlington Center

8

Y

75

NJ

Phillipsburg

Phillipsburg Mall

18

Y

30

OH

Wooster

Wayne Towne Plaza

25

Y

20

PA

Exton

Exton Square Mall

13

Y

50

PA

Hazleton

Laurel Mall

20

Y

20

PA

Washington

Washington Mall

18

Y

30

TN

Chattanooga

Northgate Mall

8

Y

75

VA

Bristol

Bristol Mall

18

Y

30

VA

Norfolk

Military Circle Mall

5

Y

75

WI

Fond Du Lac

Forest Mall

15

Y

30

WI

Janesville

Janesville Mall

32

Y

10

WI

Rhinelander

Lincoln Plaza Center

64

Y

0

WI

Rice Lake

Cedar Mall

50

Y

0

WI

Wausau

Wausau Mall

32

Y

10

Impact on Financials

The current revenue per closing store is estimated at $3.5 million annually. This is based off the assumption that these stores would have been at least near profitable in 2010 or else they would have been closed earlier. At $2 million per store in directly related costs (based on $65 million cost savings over 33 stores), each store would have needed to generate $5.02 million in revenue to break even at 39% gross margin. Reducing revenues by J.C. Penney's 30% same-store sales decline since 2010 would get us to the $3.5 million number. The $3.5 million per store figure likely represents the low end since the stores may have operated above breakeven in 2010.

The stores will still be operational for Q1 2014, so we are estimating that revenue at the closed stores from Q2 to Q4 would have been $90 million (around 78% of the full year total).

J.C. Penney is expected to recapture 30% of sales at these closing stores via other locations. Hence the amount of sales lost during 2014 would be $63 million and the amount of gross margin lost would be $22.05 million at 35% gross margin. This would increase to $84.49 million in lost sales and $31.68 million in lost gross margin in 2015 if J.C. Penney had 4.5% sales growth and improved gross margin to 37.5%.

As a result, J.C. Penney's EBITDA (excluding the $43 million in charges related to store closures) is expected to improve by $27.95 million in 2014 and $33.32 million in 2015 as a result of these changes. We assume that the $65 million yearly run rate in cost savings starts at the end of Q1. The effect on net income would be negative $26 million in 2013, positive $10.95 million in 2014 and positive $33.32 million in 2015. J.C. Penney will break-even on the store closures by Q2 2015.

2014 Q2-Q4

2015

Estimated Sales At Closing Stores ($ Million)

$90.00

$120.70

Sales Lost (%)

70%

70%

Sales Lost ($ Million)

$63.00

$84.49

Gross Margin Lost ($ Million)

$22.05

$31.68

Cost Savings ($ Million)

$50.00

$65.00

Net Impact on EBITDA ($ Million)

$27.95

$33.32

Other Charges ($ Million)

$17.00

$0.00

Impact on Net Income ($ Million)

$10.95

$33.32

Other Effects of Store Closures

Another effect would be the expected reduction of inventory by around $65 million. This is based on expected 2013 year-end inventory of $2.85 billion across approximately 1,095 stores, which comes out to $2 million per store after allowing for some inventory residing in warehouses and e-commerce distribution centers.

When this inventory impact is combined with the store closure charges and improved EBITDA from the closures, liquidity at the end of 2014 is expected to improve by $50 to $75 million (if only $20 million of the store closing costs are cash charges). This assumes that inventory from closing stores is completely liquidated and is not redistributed to other stores.

Other minor impacts would be on gross margin (depending on the level of clearance discounts required, gross margin could be affected by a marginal amount - under 1% in Q1 and Q2 2014) and capital expenditures (maintenance capital expenditures will probably decrease by $5 million per year).

Can J.C. Penney Close More Stores?

Although we believe that J.C. Penney should close more stores, it may be constrained by loan terms and long-term leases. As Credit Suisse's Michael Exstein noted, most of J.C. Penney's owned stores are collateral to its $2.25 billion term loan. Only two of the 33 store closures were stores owned by J.C. Penney. As well, J.C. Penney would need to negotiate its way out of leases that aren't due to expire soon. Many of its weakest stores are at malls that would have some difficulty finding new tenants. For example, Gulf View Square Mall had an 18% vacancy rate in 2011, much higher than the 7% national average.

Conclusion

J.C. Penney's move to close 33 underperforming stores is a step in the right direction. However, as analysts estimate that J.C. Penney will incur a net loss of $800 million next year, a $33 million increase in net income for 2015 only represents a modest improvement. To achieve a significant improvement in financial health via store closures will require closures in the magnitude of 200 to 300 stores.

Source: J.C. Penney: Store Closings Are A Small Step In The Right Direction, But Much More Is Needed