How Bulls Have Moved The Goalposts As J.C. Penney Falls Short Of Expectations

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 |  About: J.C. Penney Company Inc. (JCP)
by: Elephant Analytics

One thing that is interesting about the bull argument for J.C. Penney (NYSE:JCP) is that now there is an insistence that J.C. Penney at $5 or $6 is priced for bankruptcy. Bulls also argue that even flat sales for a lengthy period of time is OK since J.C. Penney might be able to survive for a while without filing for bankruptcy, and if J.C. Penney avoids bankruptcy then it is currently undervalued. However, a look back at bull articles from November shows that their argument at that time indicated an expectation for 10%-plus sales growth in Q4. Back then, one bullish article mentioned that a J.C. Penney that made $800 million in EBITDA would be worth $4 per share and that it would muddle along as an "out of court zombie" in that case.

Now that J.C. Penney is falling far short of the 10%-plus sales growth projected by many bulls in Q4, suddenly 2% growth is OK and a situation where they fall short of $800 million EBITDA for an indefinite amount of time is also fine.

The reality is that a J.C. Penney that struggles along with flat or near flat sales is not worth $6 even if it avoids bankruptcy for a while. Bulls would have agreed with that statement in November, but faced with the reality of Q4 sales being much lower than expected, they have tried to move the goalposts rather than critically evaluate their previous arguments.

The $800 Million EBITDA Scenario

Here's a look at what it would take for J.C. Penney to reach $800 million EBITDA, which would make J.C. Penney worth around $4 per share with $3.6 billion in net debt (a conservative assumption). With 37% gross margins, J.C. Penney would need to increase same-store sales by 9.0% even with SG&A reductions from the current rate of approximately $4.08 billion (including the effect of recent store closures). With 39% gross margins, J.C. Penney would still need to grow same-store sales by 3.4%. I don't believe that 39% gross margin is even achievable given the heavy competition within retail recently, and an increasing proportion of Internet sales that have lower margins due to associated shipping costs (Kohl's e-commerce gross margin was 25% due to shipping impact). Therefore, J.C. Penney is likely needing to increase same store sales by at least 6% to get to $800 million EBITDA.

37% GM

38% GM

39% GM

Required Revenue ($ Million)

$12,838

$12,500

$12,179

Gross Margin ($ Million)

$4,750

$4,750

$4,750

SG&A ($ Million)

$3,950

$3,950

$3,950

EBITDA ($ Million)

$800

$800

$800

Required Same-store Growth (%)

9.0%

6.1%

3.4%

Click to enlarge

A Challenge To Bulls

One question that I would like to pose to bulls is how long is an acceptable period of flat to minimal growth for J.C. Penney? I think that accepting minimal growth for 1-2 years and then expecting J.C. Penney to suddenly get back to $14+ billion sales after that point is a situation with low enough odds to warrant a price that is substantially less than $6 per share. Either J.C. Penney starts showing increasing growth fairly quickly, or by the metrics used in previous bullish articles it is worth less than $6 per share. J.C. Penney at $2 may be priced for bankruptcy. J.C. Penney at $6 is priced for high-single digits growth and 37% gross margin at the very least.

Conclusion

I have looked over the bull articles from November and noticed that many of the long arguments for J.C. Penney have changed. Growth of 10%-plus was expected before, and now 2% is considered acceptable. A J.C. Penney with low-to-mid single digits sales growth and $800 million in EBITDA was considered an "out of court zombie" and worth only $4 per share before. Now, a situation where J.C. Penney is scraping along with flat sales and barely avoiding bankruptcy (if it does) is said to make J.C. Penney an attractive investment at current prices of $6 per share.

If we were to use the bullish arguments from November, to be worth even $4 per share, J.C. Penney needs to reduce SG&A from current levels and achieve at least 6% same-store sales growth. J.C. Penney may be able to reduce SG&A further and increase efficiency by closing additional stores, but in a future article I will outline how that still makes J.C. Penney worth approximately $4 per share or less if there is no associated sales growth. Closing an additional 200 of the weakest stores, restoring gross margins to 37%-38% and reducing SG&A by 20%-25% from current levels should get J.C. Penney to near the EBITDA level that bulls have previously identified as making J.C. Penney worth $4 per share.

Disclosure: I am short 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.