Countdown At J.C. Penney, An Opportunity For Speculators

| About: J.C. Penney (JCP)


J.C. Penney will report financial data for Q1-2014 after market on May 15, 2014.

Chart of JCP stock prices for final week of Q4-2013/4 is included.

Explanation that components of gross profit margin are more important than EPS to determine future of JCP.

Chart is displayed that shows possible trading strategy after JCP Q1-2013/4 financial report is published.

J.C. Penney first quarter reporting provides trading opportunity.

On May 15th J .C. Penney (NYSE:JCP) will report Q1-2014 financial results after market close. An average of fourteen analysts' consensus estimates project that JCP will show a loss of $1.25 per share compared to an adjusted Q1-2013 loss of $1.31.

In the few days remaining before JCP's Q1-2013/4 report is published, stock price volatility may increase. No important information has been published since JCP's hiring of Mike Rogers as JCPs Omni-Channel expert and Oliver Chen's pronouncement that JCP is a buy. The stock price will be essentially a function of investor psychology.

I have included a chart for JCP stock prices for the week ending February 26, 2014, when the company announced its Q4-2013/4 financial results. This information may assist you with an opportunity to profit from very short-term trading.

J.C. Penney suppliers, stake-holders, speculators and employees also await the news of Q1-2013/4 reporting, which may determine the future of JCP, not because it reveals J.C. Penney's viability, but because the interested parties' relationship may be deeply influenced by their consideration of its financial condition. At the end of this article, I show how I may invest with JCP, dependent upon Q1-2014/3 financial results.

Earnings appear to be an important measure to assist in determining a business' future. Forecasting this metric is the favorite activity of speculators. Stock prices are influenced by the announcement of earnings. Earnings results are easy to interpret. The more the better, but the future of business is more complicated than may be determined by this single calculation. Casual onlookers depend on simple measurements to evaluate enterprises, but experts interpret data that is difficult to obtain and to analyze. Experts predict the future, while an observation of earnings tells mostly about the past.

When dealing with a troubled company such as J.C. Penney, the evaluation and improvement of financial issues, which indicate substandard performance, is the starting point for restoration.

How financial results impact a company's future.

The first measure often examined is selling, general and administrative expenses (SG&A), an important component of earnings. As important as SG&A is, its impact may not always be a significant factor in determining business difficulties. For example, if a company spends a large amount to increase sales staff in order to immediately improve its ability to profit from increased sales, then earnings might immediately falter but the company's future ability to profit may increase.

Increasing revenue and percentage gross profit [GM] are significant ways to improve financial performance. This is not easy process achieve, but it is what J.C. Penney claims it will do with planned phases 2 and 3.

Gross profit is sales volume multiplied by GM, and is the most informative factor whose fluctuation may alter a failing business' descent. J.C. Penney is working diligently on increasing GM and increasing revenue.

These two elements work against one another. As one increases GM, revenue will usually decrease, and vice-versa. This movement is not because small changes in price seen by the individual customer will inhibit sales, but rather an increase in GM indicates a decrease in promotional activity. The reduced advertising driven by price promotion reduces revenue.

Balancing revenue and GM to optimize financial results is a difficult task. There exists a tendency for a business to increase GM as though this act may decrease sales volume. Simple math shows that a specific increase in GM matched by the same percentage decrease in revenue increases total gross margin. Business bias often tends toward the process of increasing GM since it is the easiest method to provide immediate cash to a business operation. My speculation is that increasing GM is what J.C. Penney has attempted to accomplish this past quarter.

If JCP did increase GM, and this amount were matched by a similar percentage decrease in sales, it would have increased total gross margin. This result sounds beneficial until one looks at the shortfall of 24.8% revenue comparing year 2012 to 2013. This amount is so large that further decrease in sales might begin a total collapse of JCP. The naïve investor might see a decrease in loss over the last reporting period fueled by GM increase as a positive step and become hopeful that JCP is on its way to recovery. A more experienced investor will view the decrease in sales as a point of no return.

A stock valuation model dependent on financial results.

I am predicting Q1-2014 gross profit of $840 million, an increase of $32 million over Q1-2013 when gross profits were $812 and GM was 30.8%. My prediction of GM for Q1-2013/4 is 31.5%, which will indicate sales of $2.666 billion.

If I am correct with my gross profit amount but incorrect with my estimate of GM, a Q1-2014/3 GM of 32.5% will indicate sales of $2.585 billion, which will be a decrease of $51 million over Q1-2012/3 sales of $2.636 billion

A Q1-2014/3 GM amount of 29.5 % will indicate sales of $2.875 billion, showing an increase of $239 million over Q1-2012/3 sales.

If GM is low and sales rise above $2.85 billion, then the investment community might excuse JCP as still adjusting poor inventory purchases that originated with previous management. If sales fall below the sales of Q1-2012/3, there will be no forgiveness from the investment community, which will recognize that these declining sales indicate troubles that cannot be reconciled.

I am providing a list of possible buying/selling actions that should be evaluated after Q1 reporting on May 15, 2014. It is based on investigation, experience and data correlations that I have studied or performed. It represents my conclusions, and is not a recommendation for a reader to trade any equity or derivative.

Click to enlarge

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.