J.C. Penney Earnings Preview: It Is About Operating Cash Flow

| About: J.C. Penney (JCP)

J.C. Penney (NYSE:JCP) is scheduled to report its fiscal Q4 '14 financial results on Wednesday, February 26th, 2014 after the closing bell.

Analyst consensus per Thomson Reuters is looking for a loss of $0.82 in earnings per share (EPS) on $3.85 billion in revenue for expected year-over-year declines in revenue of 1% but a 58% y/y improvement in EPS. Last year's Q4 saw $3.88 billion in revenues and an actual EPS loss of $1.95 per share.

The 1% y/y decline in expected revenues will be the lowest y/y decline in revenues since May, 2011 when revenue growth was flat year-over-year.

After hitting a high of $87 per share in early 2007, it's safe to say that JCP has seen better days, but we won't rehash the Ron Johnson and then the Ullman fiascos again.

For us, the basis for a sustained JCP turnaround is the ability of JCP's management to generate consistent, sustained cash-flow-from-operations or operating cash-flow (OCF) and as of yet, that ability is not in evidence.

Here is the JCP's Statement of Cash-Flow as we have modeled it on an Excel spreadsheet:

2/14 q4 11/2/13 q3 8/13 q2 05/13 q1 02/13 q4 11/12 q3 08/12 q2 05/12 q1 02/12 q4 11/11 q3 08/11 q2 05/11 q1 02/11 q4 11/10 q3 08/10 q2 05/10 q1
Cash from operations ($737) ($708) ($752) $161 $161 $161 $161 $205 $205 $205 $205 $148 $148 $148 $148
Cash from investing ($128) ($383) (196) ($57) ($57) ($57) ($57) ($218) ($218) ($218) ($218) ($121) ($121) ($121) ($121)
Cash from financing $557 $1,805 839 ($3) ($3) ($3) ($3) ($266) ($266) ($266) ($266) ($124) ($124) ($124) ($124)
Net change in cash ($308) $714 ($109) $101 $101 $101 $101 ($279) ($279) ($279) ($279) ($97) ($97) ($97) ($97)
Cash from operations ($737) ($708) ($752) $161 $161 $161 $161 $205 $205 $205 $205 $148 $148 $148 $148
Capex ($161) ($439) ($214) ($58) ($58) ($58) ($58) ($159) ($159) ($159) ($159) ($125) ($125) ($125) ($125)
Free-cash-flow ($898) ($1,147) ($966) $104 $104 $104 $104 $47 $47 $47 $47 $23 $23 $23 $23
4q trailing CFO ($2,036) ($1,138) ($268) $645 $689 $733 $776 $820 $763 $706 $649 $592
yoy growth
4q trailing capex ($872) ($768) ($387) ($230) ($331) ($432) ($533) ($634) ($600) ($567) ($533) ($499)
y/y growth
4q trailing FCF ($2,907) ($1,906) ($655) $415 $358 $301 $243 $186 $163 $140 $116 $93
yoy growth
FCF Yield
FCF as % of market cap
4q trailing net income ($1,975) ($1,609) ($1,170) ($985) ($520) ($540) ($379) ($152) $206 $393 $393 $389
CFO as % of net income 1.03 0.71 0.23 (0.65) (1.32) (1.36) (2.05) (5.39) 3.70 1.80 1.65 1.52
Margin analysis
Gross margin 29.5% 29.6% 30.8% 23.8% 32.5% 33.2% 37.6% 30.2% 37.4% 38.3% 40.5% 37.6% 39.0% 39.4% 41.5% 0.0% 0.0%
y/y change -3.1% -3.7% -6.8% -6.4% -4.8% -5.1% -2.8% -7.4% -1.7% -1.1%
Operating margin -14.4% -14.8% -18.4% -19.2% -5.3% -6.1% -7.2% -1.3% -4.3% 2.1% 4.1% 8.0% 3.0% 2.4% 3.9%
y/y change -9.10% -8.78% -11.27% -17.84% -1.04% -8.13% -11.25% -9.38% -7.25% -0.34% 0.14%
Net income margin
y/y change
Click to enlarge

* Source: internal Excel spreadsheet from earnings reports and 10-Qs

* Regarding the operating cash-flow line on the spreadsheet, up until mid 2014, when we had the analyst construct the s/sheet, the annual cash-flow was simply divided by four for the quarterly data. JCP is still generating all its positive cash-flow in the holiday quarter each year, however, by using the "4-quarter trailing" or the trailing twelve month data, the cash-flow volatility is smoothed and the reader gets a better feel for the trend;

JCP has lost $2 billion in OCF the last year and $2.9 billion in free-cash-flow, and is still closing stores, which means the company is not growing stores or square footage that I can tell.

Margins have gotten crushed, with gross margin down 10% from its 40% norm in mid-2011.

One critical point for readers: "liquidity" is not cash-flow. Cash-flow from operations is generated primarily from the income statements, plus changes in working capital, and is also not changes in cash-flow from investing or financing activities.

Liquidity is simply ample balance sheet cash or reserves to fund current operations and meet any debt maturities.

Liquidity and cash-flow are two very different precepts that portend very different things for the analyst/investor: a company that doesn't generate adequate operating cash-flow will eventually run out of liquidity, (or should run out of liquidity, all other things being equal), while a company that does generate adequate operating cash-flow should eventually generate adequate liquidity.

Turnarounds in brand management are legion down through the years, and happen all the time in the consumer space, but usually two essential factors have to be present to sustain a turnaround:

1.) The brand has to be untarnished, meaning whatever caused the decline of the brand (think Arthur Andersen) has to be temporary and not severe in the public eye;

2.) There must be adequate cash and cash-flow to sustain the turnaround through the initial period of new management and operations;

It is unclear whether JCP has either right now.

I actually took a poll of our clients in November '13 and asked them about JCP's brand and whether clients shopped there, and most of the comments were positive, I'd say over 80% of the responses were more positive than negative. A few clients talked about the better look of the stores, and one client gushed over the home furnishings department, while one client mentioned that the employees were still dressed shabbily and looked like they had just rolled out of bed.

I don't know that JCP is out of the game so to speak. However, at this point we are out of the stock, and need to see better operating cash-flow before making a bigger commitment to the shares.

We sold our position in JCP in early February '14 when the stock traded under $5 per share, and below last October's low of $6.24. (We tend to NOT hold stocks trading under $5 within client accounts.)

This is all about survival for JCP, and not just limping along.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.