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Although I have been labeled an uber-bear and received criticism for being too pessimistic, it is notable that this is the second time that I have had to make a downward revision to my projections for J.C. Penney's (NYSE:JCP) Q4 2013 report due to the projections being too optimistic. If an uber-bear has been proven to be too optimistic about J.C. Penney's results, that is certainly not a good sign for J.C. Penney.

J.C. Penney's latest financial update puts it on track for approximately $3.785 billion in revenues for Q4, significantly below the average analyst estimate of $3.91 billion.

Perhaps more importantly, these results further support the idea (mentioned in October) that J.C. Penney has had flat seasonally-adjusted sales throughout 2013. Retail turnarounds are slow, but after nearly 10 months there should be at least modest sales improvements. Instead there has been essentially none. Without sales growth, even bullish value calculations cannot come up with a value for J.C. Penney that is above current share prices.

Q4 2013 Projections

On December 10th, I estimated that J.C. Penney would generate $3.918 billion in revenue and record a $266 million loss in Q4.

On January 21st, I revised this downward to $3.837 billion in revenue and a $316 million loss (including $26 million in store closing charges).

As a result of J.C. Penney's latest update, this has been further revised downward to $3.785 billion in revenue and a $332 million loss (including the store closing charges).

Month

($ Million)

Same-store Growth

November

$1,242

10.1%

December

$1,962

-0.9%

January

$581

-3.6%

Total Q4 2013

$3,785

2.0%

I have kept gross margin at 30%, although the omission of gross margin information in the most recent update leads me to believe there is some marginal downside risk to gross margin levels in Q4. Other information remains the same as in previous Q4 projections.

(in $ Million)

Q4 FY2013

Net Sales

$3,785

COGS

$2,650

Gross Margin

$1,135

  

SG&A

$1,145

Total Pension

$34

Depreciation and Amortization

$165

Total Operating Expenses

$1,344

  

Net Interest Expense

$97

  

Net Loss (Before Store Closing Charges)

-$306

What This Means For J.C. Penney

J.C Penney achieved 2.0% same store growth with the help of extra opening hours on Thanksgiving/Black Friday and the effect of Hurricane Sandy in 2012. The effect of these two items was estimated at between $65 million and $85 million. Note that this was predicted prior to J.C. Penney's November update, so it was not an attempt to spin J.C. Penney's November numbers post report. Removing the impact of these two items would eliminate the 2.0% same store growth that J.C. Penney posted in Q4.

Aside from that, Q4 2013 had the easiest year-over-year comps for J.C. Penney. If J.C. Penney can only post +2.0% same-store growth against the easiest comps, with the benefit of extra opening hours as well, it has a tough task just to record positive growth in Q1 2014.

Here's a look at the two-year stacked comps for J.C. Penney, comparing to the pre-Ron Johnson period in 2010 and early 2011. Q1 2013 performed slightly better than Q4 2012, indicating that year-over-year comps for Q1 2014 are likely to be slightly tougher than Q4 2013.

Two-Year Stacked Comps

% Change

Q2 2012

-20.5%

Q3 2012

-27.3%

Q4 2012

-32.9%

Q1 2013

-32.4%

Below is a look at the three-year stacked comps figures for the last three quarters. There is still a distinct downward drift in the three-year stacked comps.

Three-Year Stacked Comps

% Change

Q2 2013

-30.0%

Q3 2013

-30.8%

Q4 2013

-31.6%

I've been using 2010 often in previous articles as a benchmark (since it was a year with mostly stable sales and was pre-Ron Johnson era. Below is the quarter-over-quarter change in sales during 2010 and extending into Q1 2011.

 

Q1 FY2010

Q2 FY2010

Q3 FY2010

Q4 FY2010

Q1 FY2011

Revenue ($ Million)

3929

3938

4189

5703

3943

% Chg (Vs. Previous Quarter)

 

0.2%

6.4%

36.1%

-30.9%

If we apply the same percentage change to the actual revenue results of the previous quarter (starting with Q1 2013), we get the following results. Using this method would have given reasonably accurate results for each quarter (within a couple percent for Q2 and Q3, and nearly spot on for Q4). J.C. Penney has been following historical sales patterns throughout 2013.

Using the same method for Q1 2014 results in a projection of $2.617 billion in revenue, which would indicate 0% to -1% same store growth.

 

Q1 FY2013

Q2 FY2013

Q3 FY2013

Q4 FY2013

Q1 FY2014

Projected Revenue ($ Million)

2635

2641

2833

3783

2617

Actual Revenue ($ Million)

2635

2663

2779

3785

 

J.C. Penney's Value With No Growth

My main mistake when projecting J.C. Penney's results has been to assume that J.C. Penney would start displaying at least modest seasonally-adjusted growth. After nearly 10 months without Ron Johnson there has been no progress towards growth, and with every passing month the odds decrease that lost customers come back. J.C. Penney is trying to win back customers that have left J.C. Penney and shopped elsewhere for nearly two years now.

In a no growth situation, J.C. Penney is not worth very much even with very favorable assumptions about SG&A and gross margin. Even with a reduction in SG&A to $4 billion and 39% gross margin, J.C. Penney will only generate $602 million in EBITDA. At an EV/EBITDA multiplier of 6x, J.C. Penney's shares would be worth under $1 with net debt of $3.5 billion. Such a scenario would also result in negative free cash flow for J.C. Penney due to $400 million in interest and $300 million in capital expenditures (at a minimum level). There is also significant downside risk if gross margin does not reach 39% or SG&A isn't reduced to $4 billion per year.

Revenue ($ Million)

$11,800

Gross Margin ($ Million)

$4,602

SG&A ($ Million)

$4,000

EBITDA ($ Million)

$602

Conclusion

J.C. Penney's Q4 results were weaker than what many bears expected and represent four consecutive quarters of flat seasonally-adjusted growth. As the periods of flat growth accumulate, and J.C. Penney's lost customers continue to stay away, the scenario of continued flat growth becomes increasingly likely. Bulls like to assume that sales will reach $14 to $15 billion while improving gross margin and reducing SG&A. I fail to see how the hordes of customers who have deserted J.C. Penney for one to two years now will suddenly come back. Once consumer shopping habits are ingrained, it is very difficult to change them. J.C. Penney figured out a way to drive away a lot of customers quickly, but are now finding that it is much tougher to win them back once they have been successfully shopping elsewhere and building new shopping habits for one to two years.

Under the no growth scenario, J.C. Penney is eventually worth under $1 even with 39% gross margins and reduced SG&A. However, it is likely that some sort of dramatic restructuring will occur before J.C. Penney reaches those levels. A re-sized J.C. Penney with even fewer stores and a 20%+ reduction in SG&A at the corporate level and at least has a hope of being modestly free cash flow positive, although J.C. Penney may need to raise additional funds to deal with store closing costs and severance packages on that large scale.

Source: J.C. Penney: Underperforming Even Bear Expectations