It is hard to know exactly what the market expects from J.C. Penney (NYSE:JCP) this week - it's game time, Q4 earnings. The sales results have been released so to a certain extent, the stock market reaction is going to boil down to a few variables: margins, liquidity, guidance, and capital markets actions.
Margins: The easiest way for JCP to turn itself around would be to return its gross margins to historical norms of high 30s and low 40s. On a relatively stagnant $12 billion in sales. 40% margins on $12 billion of sales with just under $4 billion of SGA would give the company the over $800mm in EBITDA they need to cover their interest and CapX with some free cash flow to spare. I don't think you can get that much margin expansion all at once, but it does show a path to solvency in a stagnant sales environment. If the Company generates substantially worse than 29% gross margins that it has targeted, it will be cause for concern. They will certainly need to guide to better margins as the street will not believe robust sales growth in this retail environment.
Guidance: I do not believe the Company will give any guidance as things are still in flux and there is little upside to giving a number at this point. However should they choose to guide, the key items will again be gross margins and target SGA. If those numbers are strong, $4 billion or less in SGA and mid 30s margins, the stock should be ok even with flat year over year net sales.
Liquidity: The Company needs to be at the $2 billion or above target. The heart of the bear case is that even $2 billion is not enough or not really available to the Company. Hitting the number and ideally bettering it drives a stake through the heart of the bears.
Capital Markets: Unless there is a convert done with a strategic investor: think big league private equity or a sovereign wealth fund way above market price (i.e. $10-12+ strike price), any additional equity dilution will be viewed as bad at current stock levels. While, the market may not like to see it, I would be happy with second lien bank debt and or a draw on the accordion feature of their existing debt. A billion more of liquidity that is not in the form of equity is all good from my view.
JCP needs to get through this period without any material dilution. This method would be a way to do it. Another positive transaction would be to swap bonds bought in the 60s and 70s for above market stock for a 13D type filer (the Company would have to waive the poison pill). i.e. A billion of face amount of bonds bought at a blended rate of $70 for 100mm shares of stock. The debt retirement would offset most of the stock dilution and probably be well received by the market.
Retail stocks in general and JCP in particular have been in a free fall since Christmas. Given the news already announced, this quarter should be about showing that the Company remains stable and on track to do better in a brutal environment. If the market gets that proof of life, the stock should finally bounce. My guess is that making numbers with a stable outlook should get the stock back to at least $7-8 if not higher.
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 without warning or notice.