Shares of J.C. Penney (JCP) have declined 17.95% year to date. At $28.84 per share, the stock is trading 33.2% off from its 52-week high at $43.18 achieved in February. The stock has recently been experiencing an upward price trend by recovering 51.3% from the 52-week low at $19.06. Should investors ride on this momentum? I believe this stock should be avoided due to the stretched valuations. My view is based on the following five reasons:
1. JCP is priced expensively to its growth potential (see table below). The company has a cloudy growth prospect. Analysts in average predict JCP's top line to decline by a two-year rate of 7.6% over the current and next fiscal years. However, EBITDA is estimated to grow at a two-year CAGR of 9.5% and EPS to increase from ($0.70) to $1.23 over the same horizon. Accounting for the earnings growth estimates, JCP shares trade at 1.5 times PEG, which is substantially higher than the average PEG of 0.9 times for the peer group consisting of the firm's major competitors such as Macy's (M) and Kohl's (KSS).
Click to enlarge images.
2. JCP also appears overvalued based on the firm's other fundamentals (see above table). JCP's profitability is extremely weak. The firm's LTM gross margin is the only profitability metrics that is comparable to the peer group average. Its EBITDA margin is only 2.3%, which is significantly below the peer average at 11.9%. Both JCP's LTM EBIT and net profit margin are negative. The company is also not able to generate profits on the funds invested as reflected by the negative ROIC and ROE. In addition, JCP's capital structure is fairly in line with its peers, but due to the weak EBITDA margin, the firm's LTM debt to EBITDA ratio is currently standing at 9.0 times. Moreover, JCP is the only firm in the group that is not able to generate a positive free cash flow. The firm's only bright spots tend to be the current and quick ratios as they both are slightly higher than the group averages.
Nevertheless, the current stock price of $28.84 implies a whopping average valuation premium of 105.4% over the peer-average NTM EV/EBITDA and NTM P/E multiples (assuming they are equally weighted in arriving at the stock value), suggesting JCP stock is largely overvalued as the valuation premium is extremely difficult to be justified by how the company has performed.
3. JCP stock has become so much more expensive over the past 12 months (see table below). Compared to JCP's own financials in exactly a year ago, most financial metrics have deteriorated over the past 12 months. As the current stock price remains 3% higher than what it was a year ago, the stock's NTM EV/EBITDA and NTM P/E multiples have expanded significantly by an average of 164.1% due to the company's lower profitability, and the PEG has also jumped by 62.4% from 0.9 times to 1.5 times over a year.
4. Street analysts are quite negative on the stock. According to Thomson One, of the total 21 ratings there are three strong buys, three buys, 12 holds, and three underperforms. The one-year mean target price for JCP is only $26.33, almost 9% below the current market price.
5. The recent stock recovery appears to be just a technical rally as JCP's revenue, EBITDA, and EPS estimates have almost no major upward revisions and remained depressed over the past 12-18 months (see tables below).
No one knows whether JCP will be able to make a successful turnaround, but what we do know is that the price to wait for that potential success is too expensive. As the investment offers almost no margin of safety, the stock should be avoided.
(Note: Financial estimates table is sourced from Capital IQ; all other tables are created by the author and all financial data is sourced from Morningstar and Capital IQ.)
Disclosure: I am long M.