J.C. Penney: $1 Billion EBITDA Target Still Very Achievable

| About: J.C. Penney (JCP)

Summary

Sales were weaker than expected in Q1, falling around 4% short of expectations.

This is similar to how other department store competitors performed versus expectations.

J.C. Penney can hit its $1 billion EBITDA target with +1.5% comps.

+3% comps will result in an estimated $1.068 billion EBITDA.

J.C. Penney's ability to reach that probably depends on department stores such as Kohl's posting -1% or better comps in the rest of 2016 instead of -4%.

J.C. Penney (NYSE:JCP) posted weaker-than-expected sales in Q1 2016, with the first (albeit barely) negative comps quarter since Q3 2013. However, the market reaction was fairly muted after the early morning sell-off. This is probably because there were already lowered expectations around J.C. Penney's revenue number, while the company at least maintained its sales guidance and indicated that trends improved towards the end of April and early May.

The Q1 Results

J.C. Penney's sales for Q1 2016 were weaker than I expected, with comparable store sales showing a 0.4% drop. I had thought the company could do somewhat better than the other department stores in terms of performance versus initial expectations. Instead, it missed on revenues by around 4%, which is similar to what other department stores missed their initial expectations by.

Gross margins were also relatively weak due to a higher percentage of clearance sales. J.C. Penney's gross margin came in at 36.2%, a 0.2% decrease from last year. This resulted in gross margin guidance being reduced by around 30 basis points. The company expects gross margins for the last three quarters of the year to be approximately 0.3% higher than last year.

J.C. Penney made up for the weaker-than-expected sales and gross margins by reducing SG&A by 9.6%, with reductions across all major SG&A categories. Part of the reduction was caused by the company dropping its sponsorship of the Oscars, which reportedly cost J.C. Penney around $10 million per year during 2010 to 2014 and is up to around $11 million per year now. It is uncertain how much dropping the sponsorship contributed to the negative comps in March (since the Oscars were at the end of February) after the positive comps in February. However, Kohl's (NYSE:KSS) (which picked up the sponsorship) also reported weak March sales, so whatever effect the Oscar sponsorship has on sales appears to be swamped by the effect of other items.

Going forward, J.C. Penney expects to be able to reduce SG&A versus last year, but not to the same level as Q1, which involved some extra cost-cutting measures.

Department Store Drag

J.C. Penney is doing well compared to other department stores in terms of its sales growth. However, Q1's results indicate that it is still highly affected by the general retail and department store climate. Close attention should be paid to the performance of its competitors. If a company such as Kohl's posts slightly negative (such as 0% to -1%) comps, there is a good chance that J.C. Penney can do +3% to +4% comps. However, if the environment worsens and Kohl's does -5% comps, J.C. Penney would probably need to execute extremely well just to get to positive comps.

2016 EBITDA Target

It appears that J.C. Penney should still be able to make its $1 billion EBITDA target as long as modest sales growth resumes. It mentioned that the company needed +1.5% comps on the year in order to hit that target. Therefore, if comparable store sales hit the low end of its current +3% to +4% guidance, EBITDA may reach around $1.068 billion for 2016.

The calculations go as follows. If comparable store sales grow by 3% in 2016, then sales may reach $12.94 billion. At 36.2% gross margin, that would translate into $4.684 billion in gross margin using the middle of the revised guidance range.

J.C. Penney will probably benefit from other items a bit, with the home office land joint venture potentially generating more than enough income to offset any pension expenses or restructuring/management transition charges. If the joint venture generates $50 million in income and there are $10 million in pension expenses and $20 million in restructuring/management transition charges, then the net benefit would be $20 million.

The SG&A target is estimated at $3.636 billion, based on getting to $1 billion EBITDA with +1.5% comps. Hitting that SG&A number would require a 1.6% year-over-year decline in SG&A during the last three quarters of the year to reach that total.

In $ Million

Sales

$12,940

Cost Of Goods Sold

$8,256

Gross Margin

$4,684

SG&A

$3,636

Net Other Operating Expenses

-$20

EBITDA

$1,068

Click to enlarge

2017 EBITDA Target

The $1.2 billion EBITDA target for 2017 still appears achievable, although weaker growth in 2016 would result in 2017 likely needing growth to accelerate a bit again.

If J.C. Penney can deliver +3% comps in 2016, then $1.2 billion EBITDA may be achievable in 2017 with a modest 30-basis point increase in gross margin (which would bring 2017's gross margin up to the level initially expected in 2016), combined with +2% comps.

If the company delivers +1.5% comps in 2016, then it would take +3.5% comps and a 30-basis point increase in gross margin in 2017 to reach $1.2 billion EBITDA. Alternatively, it would take around +3% comps and a 50-basis point increase in gross margin to reach $1.2 billion EBITDA.

Conclusion

J.C. Penney's conference call made me a bit more optimistic about its performance. The return to positive comps in late April and May, combined with the company's ability to reach $1 billion EBITDA with +1.5% comps means that EBITDA target should still be quite achievable. J.C. Penney also is holding its +3% to +4% comps guidance for the year, which will now take roughly +4% comps in the last three quarters to achieve. That's a fairly challenging target, but should be helped by unfavorable weather in Q3 2015 making that comparison a bit easier. The company's ability to reach its sales target will likely depend on the department store climate returning to slightly negative instead of mid-single digits negative. J.C. Penney can probably do comps that are 4% or 5% better than competitors such as Kohl's, but consistently reaching 8% better would be difficult.

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Disclosure: I am/we are long 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.