Seeking Alpha
Arbitrage, contrarian, portfolio strategy, investment advisor
Profile| Send Message|
( followers)  

Summary

  • $2.5 trillion sector with great upside potential.
  • Stock trading at more than $2.5 below book value.
  • Buy opportunity created by the recent market correction of about 10%, interrupting the stock's uptrend.

Sector Positive outlook

The U.S. retail sector continued to improve in 2013, but I believe that it has not yet achieved full recovery. Consumers are still cautious about what they buy. But retailers have reasons to be optimistic about 2014 and 2015. Consumer spending surged in December of last year after falling for three months largely due to the government shutdown. The labor markets have been showing steady improvement, and the unemployment rate reached a 5-year low by the close of 2013.

In addition, the consensus of the 48 economists, surveyed by the National Association for Business Economics is that bad weather cut first-quarter growth to a weak annual rate of 1.9 percent, but that growth could exceed 3 percent by the end of 2014. GDP is expected to grow at an average of 3.1 percent in 2015, and hourly wage growth is forecasted to rise faster than inflation in 2014. This means that we expect to see a more positive outlook for 2014, and an increase in consumer spending. The National Retail Federation (NRF) reports that retailers operate more than 3.6 million U.S. establishments that support 1 in 4 U.S. jobs - which translates to 42 million working Americans, contributing $2.5 trillion to annual GDP. Consequently, retail serves as a daily barometer for the nation's economy. Thus, if consumer spending grows, we are more likely to see an increase in sales in the retail sector. We are also going to see more sales in some retail stores as compared to others. One retail store with potential for increased sales is J.C. Penney.

Why J.C. Penney?

J.C. Penney was the most affected retailer last year. Not only is J.C. Penney in an industry with potential for growth, but it is also trading below book value. J.C. Penney is still recovering from Ron Johnson's turnaround strategy, which spurred a $1 billion loss and a 25% drop in sales in 2012. He alienated core consumers and did not test ideas in advance. Shrinkage decreased gross margins by 1.1% as inventory loss for the third quarter increased by $300,000. This recovery is likely to take effect throughout this year. With a positive industrial outlook and a positive recovery, J.C. Penney is positioned to increase sales this year.

Initiatives that are likely to drive growth

  • Expected increase in retail sales due to increased consumer spending. As reported by the LAEDC Kyser Center for Economic Research, consumer spending is expected to post gains that are more robust this year with even stronger growth over the course of 2015. Total U.S. personal consumption expenditures, a large part of which are retail sales, are expected to increase in 2014 by 2.8% compared with 2.0% in 2013, and rise to 3.1% in 2015. I believe this growth in retail is going to be more prevalent in discount stores such as J.C. Penney with heavy promotions and good marketing.
  • Going back to the basics (discount store) - J.C. Penney has brought back regular and exclusive promotions. Exclusive in the sense that the promotions have a start and an end date thus encouraging instant and periodic store visits.
  • A partnership that has already proved to be effective with potential for further growth. During the recent quarterly report, Sephora stores inside J.C. Penney showed commendable earnings. J.C. Penney has added 60 new Sephora stores during the fiscal 2013, taking the store count to 446. Sephora operates approximately 1,700 stores in 30 countries worldwide, with an expanding base of over 300 stores across North America generating over 44 billion in revenue as of 2013. Sephora stores enable J.C. Penney to draw in younger and affluent customers, thereby giving J.C. Penney a competitive edge over other beauty products, retailers and drugstores.

Concluding remarks

J.C. Penney's consumers are sensitive to macroeconomic factors such as unemployment levels, high household debt levels, increases in fuel and energy costs, and credit availability. All these factors have potential to reduce consumer sentiments, decrease discretionary spending, and ultimately affect the growth and profitability of J.C. Penney.

Nonetheless, I am more optimistic for the future of J.C. Penney. The radical changes it has initiated to capture consumer spending seem to be working, and its financial outlook is likely to be positive in the coming months. The share price estimate for J.C. Penney ranged from $9 - $11 when it was still around $8. As of January 31st, 2014, J.C. Penney's book value was close to $10.31 per share, but it is currently trading at $7.25 per share. This recent negative 10% market correction in the stock increases the incentives to own the stock. With a narrower-than-expected 4th quarter loss in the 2013 fiscal year and an upbeat outlook for the 2014 fiscal year, I believe J.C. Penney is definitely a buy now that it's trading at $7.25 per share.

Source: Why Retail? Why J.C. Penney?