J.C. Penney's Story Continues With A New Credit Line

Jun.30.14 | About: J.C. Penney (JCP)


How long can J.C. Penny continue to sell its products at discounts?

Plan with new credit line will reduce interest, but additional debt is not helping shareholders confidence.

Needs to become free-cash flow neutral before the stock will begin to rise.

JCP margins are among the lowest in the industry at 30%, compared to lead competitor Macy's at 40%.

J.C. Penney (NYSE: JCP) the Plano, Texas-based retailer of mid-range clothing, footwear jewelry, home furnishings and beauty products operates through 1,107 departmental stores across all 50 states of the US.

The company also provides services like styling salon, portrait photography and custom decorating. It also has an online presence through jcp.com. J.C. Penney also leases out its departmental store space to Sephora, the cosmetic chain and Seattle's best coffee.

The struggle continues despite positive results

J.C. Penney has been struggling for the last three years with sales declining by 30% during the period. The net losses have widened from $152 million in 2011 to $1.4 billion in 2013. The stock price has declined from $40 in early 2012 to $9 in end of 2013 reflecting the poor performance.

J.C. Penney released its Q1 2014 results on May 15, 2014, marking the second successive quarter of overall sales growth. Same-store sales grew by 6.2% to $2.8 billion, with 25% growth in online sales. The gross margin also improved 230 basis points.

In the most recent quarter, the company cut its operating loss by 50% to $247 million, due to cost reduction in real estate lease and restructuring. The EPS improved to ($1.15) from ($1.58) in Q1 2013.

Looking at these numbers, it may appear as though J.C. Penney is back on track. However, the company's real story is no better than it was a couple of quarters ago. In fact, the picture seems to be getting worse.

The company's recent ramp up in sales came as a result of huge discounted sales of slow moving inventories. This seems to have heightened traffic for the company's products, albeit because of the competitive pricing.

The big question is for how long the company would be able to continue selling its products at discounts, and whether in the event of a return to normal pricing the customers would remain loyal to the company.

That is by no means a guarantee, and given the manner in which the discounted sales are hurting the company's margins, the road seems to be rough ahead. Currently its gross margin stands at 30% (TTM) compared to rivals Kohl's (NYSE:KSS) and Macy's (NYSE:M), 37% and 40% respectively.

Therefore, the struggle is expected to continue in the near term, as the company continues to re-strategize in bid to wrestle back lost market share to its closest rivals, Nordstroms (NYSE:JWN), Macy's and Kohl's, among others.

New credit line

The company replaced its $1.85 billion credit line with $2.35 billion secured credit line at a lower pricing, which is expected to add $500 million to cash flow. The company had $4.8 billion of debt in its book increasing leverage (Debt/ Equity) to ~1.8x from ~1x last year.

While the new credit line serves the purpose of near-term liquidity, there are question marks on how this is going to win back investor optimism as the company continues to balloon its current debt. The company increased its debt by $500 million net, bringing the total debt borrowings since Ullman replaced Ron Johnson as CEO to $3.1 billion.

The company's guidance for full-year 2014 estimates a mid single-digit growth in sales and a reduced net loss. It also plans to spend $250 million capital expenditure funded through a term loan of $500 million, which is a part of the new credit facility.

The cash balance as on May 2014 was $1.1 billion. Following the sales growth in Q1 2014, the stock price improved from $6 level in early 2014 to $8.95 on June 27, 2014. The last quarter of 2013 and first quarter of 2014 are traditionally good for retailers due to holiday season in the US. Therefore, this could be as a result of seasonal seesaws, which means the next two quarters could be very tough for the company.

Therefore, if the company can continue to grow sales in upcoming quarters of 2014, there is a chance that something positive could be on the horizon. Nonetheless, even with a mid single-digit sales growth in FY2014 the company is likely to take at least three more years to become profitable.

The bottom line

J.C. Penney has traded at an average Price to Sales multiple of ~1x in the past three years. If the company continues sales growth in successive quarters and posts and annual sales growth of 5% as per its guidance, the price estimate based on projected 2014 sales of $12 billion (under a best case scenario) would be $12.

Considering the lack of investor confidence in recent times and the obvious execution risk, there is not much upside to price from current levels. Achieving free cash flow break-even will be the first cue for price breaking the $10 barrier. However, this might prove difficult, as the company's margins continue to stay far below the industry average.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.