J.C. Penney Can Make A Profit During 2014

| About: J.C. Penney (JCP)
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One of the most iconic American brands isn't going bankrupt after all - perhaps just the opposite.

I wrote an aritcle earlier this week explaining how J.C. Penney (NYSE:JCP) predicted higher margins for the coming year (2014) without explicitly stating it in a press release. With the latest earnings release and guidance, I believe even more that J.C. Penney has a strong year ahead of it.

2014 Full Year Guidance

-Comparable Store Sales: "to increase [to] mid single digits"

-Gross Margins: "expected to improve significantly versus 2013"

-Liquidity (at year end 2014) of above $2B

With an increase in cash with positive cash flow, as well as guidance to maintain liquidity at over $2B through the end of 2014, J.C. Penney does not look to be in any immediate financial trouble.

In fact, I believe that J.C. Penney can complete the rest of its turnaround with its $1.5B in cash and $500M left on the revolving credit.

Perhaps this turnaround was predicted 10 months ago, when management issued a three phase plan:

"This turnaround would come in three phases, [1] the immediate stabilization phase, followed by a [2] phase rebuilding and then [3] the go forward phase positioned JCPenney for long-term growth."

-Mike Ullman, JCP CEO, Q4 Conference Call; reflecting on previous strategies

Phases one and two have already taken place, with JCP returning to its previous days as a discount retailer, and the reorganization of its stores (you can read about this in my previous article).

Because of its previous moves, JCP was able to return to a competitive state this holiday season. The company saw a sales of gain of 3.1% over last year, showing that it can still compete in the very tight retail industry in which major retailers such as Walmart (NYSE:WMT) and Kohl's (NYSE:KSS) lost share in January.

However, the forward guidance, not past results, is what should draw investors to the company. Mike Ullman announced that JCP discontinued several brands in the quarter, including: JCP Men's, Stafford Prep, JOE by Joseph Abboud, William Rast, Joe Fresh Kids and jcp Everyday.

The discontinuation of these brands should bring to light immediate margin improvements. The improvements should show in the first quarter of 2014, and increase a substantial amount by year's end.

The gross margin in the quarter was 28.4%, compare to 23.8% last year. The gross margin for the quarter included a 190 basis point charge to the discontinuation of several brands, as well as a negative impact from several promotions. Next quarter, gross margins should exceed 31.5% because of the more profitable mix of merchandise (and guidance to beat last year's 30.8%).

Using this data, I believe that JCP will lose just $300M in EBITDA during Q1 before a tax credit:

Sales $2.7B
Gross Profit % 31.5%
Gross Profit $850M
SG&A $1B
Other Operating $150M
Operating Loss ($300M)
Interest Expense $90M
Pre-Tax Loss ($390M)

However, as the year moves on, I expect significant margin and sale improvements. The margin growth will be driven by a better mix of inventory and revenue by an increase of same store sales and JCP.com growth.

JCP.com continues to outperform, increasing revenues 26% in the quarter over the previous year (and more than 40% in January alone). If the tremendous presence of JCP continues to grow online, I believe we can see upwards of 8% sale growth over 2013.

With Ullman calling for significant margin growth, I see the number increasing from the low 30's to begin the year, to towards 35% in Q4 (for my estimates I decreased it to 33% for holiday discounts). Assuming such growth, including the increase of sales and other cuts, I believe that JCP can turn a profit in the last quarter of 2014:



Gross Profit % 33%
Gross Profit $1.37B
SG&A $950M
Other Operating $150M
Operating Profit $270M
Interest Expense $90M
Pre-Tax Profit $180M

While the next holiday season is a long ways away, with the current breakdown, JCP has the capability to turn a profit next year.

There are many ways to increase profitability next year including higher margins, revenue growth (led by JCP.com), SG&A reduction, and the minimization of interest expense through the repayment of loans (with its accumulating cash hoard).

While there are still several months left in J.C. Penney's turnaround, it seems that the company has escaped financial danger. It goes without saying that JCP should increase in share price, as it currently trades below book value (by roughly $1B) with profitability in the works. With the positive earnings surprise, it may be time for the shorts to hang their position on the rack.

The time has come for J.C. Penney to grow back into its previous stature. With the right blend of merchandise and expenses, J.C. Penney is on the road to profitability and can focus on what it knows best: how to compete in the retail sector.

Disclosure: I am 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.