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Summary

  • JPMorgan brought up the idea that store closures could significantly improve J.C. Penney's value, with potential improvement of $3 per 100 stores closed.
  • My model agrees that store closures will have a positive impact on value and EBITDA, although with diminishing returns as you close more stores.
  • The estimated improvement in J.C. Penney's value versus previous estimates is $2 for 100 store closures, and $4.50 for 300 store closures, assuming the ability to optimally close stores.
  • My estimate of the sales productivity increase versus 2013 levels required to justify J.C. Penney's current price drops to 14% with 300 store closures from 21%.

J.C. Penney (NYSE:JCP) recently received a boost from a JPMorgan report that discussed the likelihood of additional store closures and estimated that closing 100 stores would result in a $150 million improvement in EBITDA, and a $3 per share increase in value as a result. Some news reports mentioned that closing 300 stores would result in a $450 million improvement in EBITDA and a $9 per share increase in value. The latter point did not seem to incorporate the diminishing returns as you close more productive stores, so I've decided to examine how 200 and 300 store closures would affect EBITDA (and consequently share value), as well as do my own estimates for 100 store closures.

My model indicates that closing 100 stores may result in a $2 per share increase in value, while closing 300 stores may result in an approximate $4.50 per share increase in value. This is not to suggest that closing 300 stores should immediately increase J.C. Penney's value by $4.50 per share, but rather that a projected value of say $8.50 would increase to approximately $13 by closing 300 stores. Closing 300 stores would reduce my estimate of the level of sales productivity improvement (vs. 2013 levels and excluding the boost from recapturing a portion of sales at closed stores via other locations) required to justify J.C. Penney's current price from 21% to 14%.

Store Level SG&A

One of the key items to determine is how much SG&A is directly tied to store level, and therefore would translate into savings with store closures. J.C. Penney estimated that it would save $65 million per year when it closed 33 stores. However, I believe this per store rate is probably lower than average (due to lower staffing levels for stores with limited traffic and potentially that the average size of the closed stores was below average).

Out-of-store advertising appears to be roughly $500 million based on measured media spend plus agency fees. E-commerce operations, corporate office expenditures and district-level infrastructure may add another $700 million. Credit card income (expressed as a reduction to SG&A) was approximately $375 million. That leaves approximately $3.2 billion related to store-level SG&A, or $3 million per store.

Store Productivity

The following calculations are based off of two sets of J.C. Penney store data mentioned in a Credit Suisse report. The sets of data were from 2012 and 2013 CMBS deals and provided sales per square foot for 34 stores each year. While the stores in these deals are not random or necessarily representative, they do provide a rough picture of the variance in sales per square foot among stores.

The below table shows the results of that information, with the bottom 10 percent of stores in the 2012 deals averaging roughly $105 per square foot compared to the overall sample average of $166 per square foot. So the bottom 10 percent of stores averaged 63% of the average sales per square foot in the 2012 deal sample. Repeating this exercise for the 2013 deals shows that the bottom 10 percent of stores averaged 55% of average sales per square foot. Combining the two results gets us an average of 59%.

Sales Per Square Foot

2012

2013

Combined % of Average

0 to 10th percentile

$105

$78

59%

10th to 20th percentile

$115

$93

68%

20th to 30th percentile

$130

$116

80%

Median

$158

$145

 

Average

$166

$142

 

Effect on EBITDA

This following exercise is based on a J.C. Penney averaging $115 in store sales per square foot. J.C. Penney would reach this level at approximately $14 billion in revenue with its current store base, with 11% of sales coming online.

Some relatively generous assumptions are used as well. These include that J.C. Penney is able to optimally close stores (if it closes 100 stores, then the 100 stores it closes are the bottom 100 in terms of sales per square foot). This may not be entirely feasible due to length of leases and other factors. As well, I am using JPMorgan's 6.6x multiple for EV/EBITDA for comparison with their report, even though I personally believe this to be a bit high given J.C. Penney's historical multiples.

Other assumptions are that J.C. Penney can recapture 30% of lost sales via remaining stores and online, similar to my previous article about store closures. SG&A savings are adjusted slightly based on store productivity. A 10% difference in store productivity is assumed to correlate with a 2.5% change in SG&A. Therefore a store with 59% of average sales is expected to have roughly 90% of average SG&A. As well, I am assuming that all closing stores are 100,000 square feet and that J.C. Penney has 1000 stores for simplicity with percentages (10% equals 100 stores).

I am also focusing on the direct effect of store closures on EBITDA in this article, so I am not going to delve into other aspects such as potential working capital boosts (from reduced inventory levels), reduced maintenance capital expenditure requirements and store closing costs (including lease termination payments and severance). As well, there is probably a possibility of reducing some corporate-level costs with a significantly reduced store base, although likely not commensurate with the proportion of the store base being closed.

Store Ranking

Sales Per Square Foot ($)

Store Sales ($ Million)

Lost Sales ($ Million)

Lost EBITDA ($ Million)

SG&A Savings ($ Million

Boost to EBITDA ($ Million)

Effect on Share Price

0 to 10th percentile

$67.9

$678.5

$474.95

$178.11

$269.25

$91.14

$1.97

10th to 20th percentile

$78.2

$782.0

$547.40

$205.28

$276.00

$70.73

$1.53

20th to 30th percentile

$92.0

$920.0

$644.00

$241.50

$285.00

$43.50

$0.94

Closing the bottom 100 stores will result in a $91 million boost in EBITDA, improving J.C. Penney's value by $1.97 per share. Closing the next 100 will result in a further $71 million boost in EBITDA and a $1.53 per share increase in value. Closing another 100 beyond that would boost EBITDA by $44 million and increase share value by $0.94.

These numbers are also sensitive to J.C. Penney's sales levels, with the boost in share value being greater with poorer overall sales performance. Closing 300 stores would provide a significant boost if J.C. Penney was going to top out at $13 billion, but would be poor idea if J.C. Penney was going to top out at $17 billion (as you'd be closing a lot of EBITDA positive stores at that point).

Conclusion

There does appear to be some significant potential for value to be created through large scale J.C. Penney store closures. Closing 300 stores would potentially boost J.C. Penney's value by around $4.50 from what it would be otherwise. Closing 100 stores would result in a potential $2 per share boost.

This is fairly close to JPMorgan's assessment, although news reports about their note did not mention the high likelihood of diminishing returns as you close additional stores. Therefore instead of closing 300 stores creating 3x the value of closing 100 stores, the ratio is probably closer to 2.25x. As well, there is the risk of closing 200-300 stores depopulating regions of J.C. Penney stores by enough so that the assumption that it can recapture 30% of lost sales via remaining outlets would be too optimistic (as the distance to the next nearest J.C. Penney store is extended).

The result of closing 300 stores would bring my estimate of the required level of sales productivity recovery needed to justify J.C. Penney's current price down to about 14% above 2011 levels from 21% (which would have been approximately $14.3 billion in sales with its current store base).

Source: J.C. Penney: A Model For Valuing Store Closures