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Summary

  • J.C. Penney will be valued based on traditional metrics once growth slows to 3% or less.
  • J.C. Penney's current share price indicates an over/under line of $14.2 billion for revenue by the time growth slows to 3% or less.
  • If you expect greater than $14.2 billion in revenue by that point, you probably should be long J.C. Penney. If you expect less, then you probably should be short.

Traditional valuation metrics are expected to eventually be a more important factor in J.C. Penney's (NYSE:JCP) stock price. Currently J.C. Penney largely trades independently of those metrics, due to the significant uncertainty about where J.C. Penney's sales levels will end up. Once J.C. Penney's sales growth slows to a more normal department store range though, the turnaround will in effect be over, and there will be no reason to value J.C. Penney as a special case anymore.

I am defining this "normal" range as same-store growth of 3% or less. The time period for J.C. Penney's growth for returning to this range is uncertain, but is likely to be anywhere from 2015 to 2017, as it seems unlikely for a turnaround to deliver extraordinary growth for longer than that time frame.

This article will cover the scenarios where J.C. Penney reaches between $13 billion and $14.2 billion in revenue before returning to growth of 3% or less. These are bearish scenarios, as $14.2 billion appears to be the over/under line for revenue based on J.C. Penney's current stock price. If you think J.C. Penney will reach over $14.2 billion before growth slows to 3% or less, you should probably be long J.C. Penney long-term. If you think J.C. Penney's growth will slow to 3% or less before it reaches that mark, you should probably be short J.C. Penney long-term.

The bullish scenarios where revenues reach above $14.2 billion before growth slows, and the scenario where revenues fail to reach $13 billion (necessitating further store count reductions) will be covered in future articles.

Gross Margin and SG&A Assumptions

I have written in a previous article why I am using 37.5% as a long-term gross margin percentage. Since a couple of the components going into that gross margin number do improve with increased sales, I am making some slight tweaks to account for that. Gross margin is expected to increase by 0.1% for every $1 billion in sales above $13 billion.

Revenue ($ Million)

$13,000

$13,500

$14,000

$14,200

Gross Margin (%)

37.50%

37.55%

37.60%

37.62%

SG&A expectations have also been covered in a previous article. Current projections for around $4.0 billion to $4.1 billion in SG&A for 2014 appear to be validated by J.C. Penney's comments on its Q1 conference call. The baseline of $4.1 billion in SG&A for $13 billion in sales represents a 1% reduction in SG&A despite a 10% increase in sales from 2013 levels.

Revenue ($ Million)

$13,000

$13,500

$14,000

$14,200

SG&A ($ Million)

$4,100

$4,150

$4,200

$4,220

SG&A is expected to increase by $100 million for every $1 billion extra in revenue. As sales increase, there would be further merit increases as well as a need for increased staffing to handle the higher sales volumes. This rate of increase would generally put J.C. Penney on par with its peers for SG&A levels once you adjust for store productivity. For example, at $19 billion in revenue, J.C. Penney would have nearly comparable sales per square foot to Macy's. SG&A of $4.7 billion and gross margins of 38.1% at that level of revenue would translate into an EBITDA to sales ratio of 13.4%, comparable to Macy's current EBITDA to sales ratio of approximately 13.6%.

Valuations

I am using 5.6x trailing year EBITDA for these valuation calculations. As noted in a previous article, this was J.C. Penney's valuation multiple in 2011, when it projected low single-digits growth (similar to the "normal" range mentioned above). Department store valuations have remained largely unchanged since 2011. Macy's and Dillard's have shown substantial improvements in valuation since then, but have also demonstrated significantly improved performance and balance sheets.

EV/EBITDA (Trailing Year)

April 2011

April 2014

Nordstrom (NYSE:JWN)

7.8

7.8

Macy's (NYSE:M)

5.3

7.0

Kohl's (NYSE:KSS)

6.1

6.1

Dillard's (NYSE:DDS)

5.0

5.7

J.C. Penney

5.6

NA

At revenues of $14.2 billion or lower, J.C. Penney will have substantially worse performance and a weaker balance sheet than 2011 though, and should not command a higher multiple as a result. A case can be made for a higher multiple at a revenue level that produces financial performance at least similar to 2011 and also improves the balance sheet significantly from current levels.

S&P Credit Rating

April 2011

April 2014

Nordstrom

A-

A-

Macy's

BB+

BBB+

Kohl's

BBB+

BBB+

Dillard's

BB-

BB+

J.C. Penney

BBB-

CCC+

The $13 Billion Scenario

In this scenario, J.C. Penney reaches $13 billion in revenue before sales start to level off. The $13 billion in revenue translates into $4.875 billion in gross margin and $775 million in EBITDA after subtracting the $4.1 billion in SG&A. The expected Enterprise Value is $4.34 billion.

$ Million

Revenue

$13,000

Gross Margin

$4,875

SG&A

$4,100

EBITDA

$775

Enterprise Value

$4,340

Net debt in this case is expected to remain at approximately the $4 billion level, as EBITDA will not be high enough to generate significant free cash flow and reduce net debt levels.

Enterprise Value ($ Million)

$4,340

Net Debt ($ Million)

$4,000

Market Cap ($ Million)

$340

Shares Outstanding (Million)

305

Price Per Share ($)

$1.11

This would give J.C. Penney a value of $1.11 per share, although since it is still avoiding bankruptcy, the shares may end up trading at something like $4 instead.

A sign that J.C. Penney is on track for $13 billion in revenue before growth falls to "normal" levels would be growth consistently in the mid-single digits during the rest of 2014 (5% to 7%), followed by slowing growth in 2015 (under 4% growth), indicating that 2016 is likely to have growth of 3% or lower.

Below is a table showing the same-store growth levels that will result in $13 billion in

2014

2015

6.0%

3.9%

The $13.5 Billion Scenario

In this scenario, J.C. Penney reaches $13.5 billion in revenue before sales start to level off. The $13.5 billion in revenue translates into $5.07 billion in gross margin and $919 million in EBITDA after subtracting the $4.15 billion in SG&A. The expected Enterprise Value is $5.15 billion.

$ Million

Revenue

$13,500

Gross Margin

$5,069

SG&A

$4,150

EBITDA

$919

Enterprise Value

$5,148

Net debt in this case is expected to remain at approximately the $4 billion level, as that level of EBITDA will allow for normal capital expenditures, but otherwise won't be high enough to generate significant free cash flow and reduce net debt levels.

Enterprise Value ($ Million)

$5,148

Net Debt ($ Million)

$4,000

Market Cap ($ Million)

$1,148

Shares Outstanding (Million)

305

Price Per Share ($)

$3.76

This would give J.C. Penney a value of $3.76 per share, although since this is an improvement over the $13 billion scenario, a range of $4 to $6 per share appears reasonable.

A sign that J.C. Penney is on track for $13.5 billion in revenue before growth falls to "normal" levels would be growth consistently in the mid-single digits during the rest of 2014 (5% to 7%), followed by mid-single digits growth in 2015 (around 4% to 5% growth), and 2016 growth slowing to 3% to 4%.

2014

2015

2016

6.0%

4.5%

3.3%

The $14 Billion Scenario

In this scenario, J.C. Penney reaches $14 billion in revenue before sales start to level off. The $14 billion in revenue translates into $5.26 billion in gross margin and $1.064 billion in EBITDA after subtracting the $4.2 billion in SG&A. The expected Enterprise Value is $5.96 billion.

$ Million

Revenue

$14,000

Gross Margin

$5,264

SG&A

$4,200

EBITDA

$1,064

Enterprise Value

$5,958

Net debt in this case is expected to decline slightly to $3.85 billion, as J.C. Penney will make slightly more than enough to cover normalized capital expenditures of $500 million and interest of near $400 million per year.

Enterprise Value ($ Million)

$5,958

Net Debt ($ Million)

$3,850

Market Cap ($ Million)

$2,108

Shares Outstanding (Million)

305

Price Per Share ($)

$6.91

This would give J.C. Penney a value of $6.91 per share.

A sign that J.C. Penney is on track for $14 billion in revenue before growth falls to "normal" levels would be growth consistently in the mid-to-high single digits during the rest of 2014 (6% to 8%), followed by mid-to-high single digit growth in 2015 (6% to 8% growth), and 2016 growth slowing to around 4% to 5%.

2014

2015

2016

6.5%

6.5%

4.5%

The $14.2 Billion Scenario

In this scenario, J.C. Penney reaches $14.2 billion in revenue before sales start to level off. The $14.2 billion in revenue translates into $5.34 billion in gross margin and $1.122 billion in EBITDA after subtracting the $4.22 billion in SG&A. The expected Enterprise Value is $6.35 billion.

$ Million

Revenue

$14,200

Gross Margin

$5,342

SG&A

$4,220

EBITDA

$1,122

Enterprise Value

$6,351

Net debt in this case is expected to decline slightly to $3.75 billion, as J.C. Penney will make slightly more than enough to cover normalized capital expenditures of $500 million and interest of near $400 million per year.

Enterprise Value ($ Million)

$6,351

Net Debt ($ Million)

$3,750

Market Cap ($ Million)

$2,601

Shares Outstanding (Million)

305

Price Per Share ($)

$8.53

This would give J.C. Penney a value of $8.53 per share.

A sign that J.C. Penney is on track for $14.2 billion in revenue before growth falls to "normal" levels would be growth consistently in the mid-to-high single digits during the rest of 2014 (6% to 9%), followed by mid-to-high single digits growth in 2015 (6% to 9% growth), and 2016 growth slowing to around 5%.

2014

2015

2016

7%

7%

5.1%

Conclusion

To be fairly valued at its current share price, J.C. Penney needs to reach approximately $14.2 billion in revenue before growth slows to 3% or less. When J.C. Penney was at its lowest, this over/under line for revenue was approximately $13.7 billion. Those expecting revenue greater than $14.2 billion before growth slows should be long J.C. Penney long-term, while those expecting revenue less than $14.2 billion should be short J.C. Penney long-term.

A sign that revenue may reach $14.2 billion would be moderately accelerating sales growth in 2014 (probably 8% to 9% for Q4), followed by sustained mid-to-high single digits growth in 2015.

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. I would characterize my position as short long-term on JCP, and somewhat speculatively long in the short-term.

Source: J.C. Penney: Why A Turnaround Could Be Worth Less Than $8.50