J.C. Penney: Q4 2017 Earnings Review
- J.C. Penney reported strong holiday results, albeit with slightly negative comps in January. The strong results helped it beat its most recent guidance update.
- February comps are said to be noticeably improved and J.C. Penney expects Q1 2018 comps to be near +2%.
- Guidance implies flat Adjusted EBITDA growth before accounting for real estate gains, although guidance looks a bit conservative.
- J.C. Penney appears on track to handle its 2018 to 2020 debt maturities.
J.C. Penney (JCP) reported its Q4 2017 earnings on Friday and also provided some guidance for 2018. January's results brought down its Q4 2017 comps a bit, but the holiday season was still strong enough to result in J.C. Penney slightly exceeding its most recent full year guidance range.
J.C. Penney's 2018 guidance implies flat Adjusted EBITDA growth before the impact of real estate. This is primarily beneficial for its debt situation as it would help J.C. Penney to generate $200 million to $300 million in free cash flow during the year. The common stock is mainly looking for J.C. Penney to beat its guidance, which does appear slightly conservative this time.
Q4 2017 Results
J.C. Penney's Q4 2017 comps ended up at +2.6% after its November/December holiday update mentioned +3.4% comps at the time. That means that January's comps were a bit sluggish, estimated at approximately -1.3%. Despite the slow end to the quarter, Q4 2017 was strong enough to push J.C. Penney's full year comps to +0.1%, modestly exceeding its most recent guidance for -1.0% to 0.0% full year comps. J.C. Penney indicated that it was running some tests during January, which may have affected sales. February sales were positive and J.C. Penney believes that Q1 2018 comps could end up near +2%.
J.C. Penney managed to achieve the Q4 2017 growth without being as overly promotional as 2016, as it increased its Q4 gross margins from 33.1% in 2016 to 33.6% in 2017. This was in-line with expectations and also came despite the negative gross margin impact of increased omnichannel and appliance sales.
While SG&A was up slightly during the quarter, this also includes the impact from the 53rd week, which J.C. Penney previously estimated would add $30 million to SG&A. The 2.0% full year reduction in SG&A is at the better end of J.C. Penney's -1.0% to -2.0% SG&A guidance.
The combination of comps slightly above the high end of guidance, SG&A reduction at the high end of guidance and gross margins in-line with guidance resulted in J.C. Penney's earnings beating its most recent guidance, although falling short of its initial guidance.
Based on J.C. Penney's comments, its 2018 results should look roughly like the table below at the midpoint of its guidance. Net sales will end up at roughly $12.09 billion with a +1% increase in comparable store sales, while 35.1% gross margins and $3.385 billion in SG&A combined with $55 million in net real estate would result in approximately $915 million in Adjusted EBITDA.
|2018 Outlook||$ Million|
|Net Real Estate||$55|
This would also translate into around the midpoint of J.C. Penney's expectations for $0.05 to $0.25 in adjusted net income.
Notes On Outlook
I believe that J.C. Penney's 2018 guidance looks pretty achievable and seems likely to be an improvement over 2017's situation where it was forced to revise its guidance downward multiple times.
J.C. Penney's potential guidance for 35.1% gross margins during 2018 would be a 0.5% improvement over 2017, but also a modest decrease versus 2017's estimated 35.55% gross margins after taking out the effect of liquidation sales, accelerated clearance and elevated shrinkage. The decrease versus that adjusted number could be largely attributed to continuing increases in omnichannel and appliance sales, and I think there could be a bit of upside to gross margins.
J.C. Penney's guidance for +0% to +2% comps may seem fairly modest given that it did roughly +1.2% over the last three quarters of 2017. However, it is also coming up against some tougher comps due to a full year of appliance sales in 2017 as well as the sales boost from accelerated clearance in Q3 2017. Appliance sales appear to still be growing strongly, but they will contribute significantly less to comps growth in 2018.
J.C. Penney should be able to reduce SG&A by a couple percent due to the lack of a 53rd week during 2018 as well as the full year of a smaller store base and its recent cost cutting initiatives.
Adjusted net income may end up lower in 2018 than in 2017, but that is largely due to a lower expected amount of real estate gains. Without real estate gains, J.C. Penney's guidance for 2018 implies approximately the same amount of Adjusted EBITDA and net income as 2017.
J.C. Penney's overall guidance for 2018 looks slightly conservative and I think that there is a better chance that it will exceed guidance rather than underperform it. This would be a welcome change from the downward guidance revisions in 2017.
If J.C. Penney meets guidance, it will essentially deliver the same bottom line results (before including real estate) as in 2017. That static situation is probably why the common stock didn't react particularly well to the guidance, although J.C. Penney should still be able to improve the value of the common stock somewhat through the expected debt paydown during the year.
A static situation appears to be more beneficial for J.C. Penney's debt though. Flat Adjusted EBITDA growth resulting in $200 million to $300 million of free cash flow per year is fine for managing its debt, as it has $725 million in 2018 to 2020 debt maturities now and beyond that no maturities until its 2023 secured debt.
I remain primarily long J.C. Penney via its KTP bond trust.
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