J.C. Penney: Cash-Flow Improvement, But Dilution Is The Risk

Aug.26.14 | About: J.C. Penney (JCP)


Looks like a technical breakout today in J.C. Penney.

The last earnings report showed a sharp reduction in free cash flow deficit.

The retailer still not expected to show a profit until 2018.

J.C. Penney (NYSE:JCP) the oft-maligned retailer, looks to be showing a technical breakout today above the $10.30 level, which we cited in our earnings preview on JCP as the level the stock needed to clear to demonstrate some improvement on the chart.

JPMorgan's analyst was out with some positive comments this morning, and was featured on CNBC this morning.

The fact is, the last earnings report wasn't bad, and in fact, was very positive in some spots, as the cash-flow deficit improved and the expense trends continued their improvement.

We bought the stock for clients last week after the initial trade above $10.30, only to see JCP trade back below $10.30 towards the end of last week.

Here were the fundamental positives we saw from the recent JCP earnings report:

1.) Without a doubt, the positive cash flow from operations (CFO) was the best metric we saw. Normally JCP, since the downturn, has only posted positive CFO in the holiday quarter. The fact that JCP could do this during a non-seasonal quarter is huge;

2.) 6% comps and the 2nd consecutive quarter of positive revenue growth were also good metrics;

3.) Expense growth has slowed dramatically, with operating expenses down from $1.67 billion in Jan. '13 to just over $1 billion as of 7/14. That trend needs to continue, although one analyst noted that last quarter's improvement may not continue;

4.) Gross margin improvement was well ahead of expectations.

Negatives to the quarter:

1.) The free cash flow deficit is improving rapidly, but will the cash flow metrics improve enough to offset the risk of dilution? The risk of JCP offering additional shares to improve liquidity, as it did in the fall of 2013, will likely overhang the stock;

2.) The fact is there isn't any store growth, which can be a positive for stabilizing the retailer, but some store growth would be helpful, or else market share losses will return;

3.) JCP is in the most pressured part of the market by Amazon (NASDAQ:AMZN) and Wal-Mart (NYSE:WMT). General merchandise retailers will continue to be squeezed by the WMT-AMZN juggernaut. Could JCP be suffering from a structural cost problem? Yes, but through the operating margin, management is working on that as well;

4.) Dilution risk is the biggest risk facing JCP shareholders right now. It is worth repeating.

We couldn't attach our spreadsheet to show the improvement in cash flow and free cash flow due to technological issues with Seeking Alpha. Once we get these resolved, we'll post the spreadsheet.

After bottoming at a $3 billion 4-quarter trailing deficit in the November '13 quarter, free cash flow on a 4-quarter trailing basis was at a $1 billion deficit as of this latest quarter. Part of that "fix" was the equity offering last fall.

If JCP management can continue to shrink the free cash flow bleeding without dilution, the common stock could really bounce.

Disclosure: The author is long JCP, WMT, AMZN.

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.