J.C. Penney Looks Like a Long-Term Bankruptcy Candidate

Earlier this month, retail analyst Charles Grom of Sterne Agee initiated coverage on troubled department store operator J.C. Penney (NYSE: JCP  ) with a buy rating and a $23 price target, which is about 30% above its recent trading range. Grom bases his valuation on a long-term view that J.C. Penney could generate EPS of $2 by 2017. That implies that J.C. Penney would more or less replicate its adjusted EPS of $2.16 from 2010, before the company's recent turmoil.

Grom's bullish call on J.C. Penney is refreshingly courageous; most Wall Street analysts tend to be overly focused on short-term results, rather than long-term trends. By contrast, Grom is clearly focused on long-term opportunities at J.C. Penney, not short-term sales or profit results.

Unfortunately, even from a long-term perspective, there's not much to like about J.C. Penney. The company was already under pressure before its missteps under Ron Johnson. The mid-price department store segment is not a great place to do business these days, as Sears (NASDAQ: SHLD  ) can attest. Moreover, J.C. Penney has taken on billions of dollars in new debt to fund its capital expenditures and operating losses, adding over $100 million of annual interest payments.

Regaining the $5 billion in sales that it has lost over the last six quarters could take more time than the company can spare, raising the likelihood of an eventual bankruptcy restructuring.  As a result, investors should be very wary of this stock.

Transformation gone awry
Ron Johnson was hired two years ago in order to transform J.C. Penney because the department store concept was going stale and financial results were starting to go sideways. In the last year of CEO Mike Ullman's previous tenure -- Ullman was recently brought back as CEO, just a year and a half after his ouster -- the company posted a dismal 0.2% comparable-store sales gain.

The external environment has not improved since then, while J.C. Penney has gone into a tailspin; the company lost more than $1.5 billion before taxes last year. Moreover, J.C. Penney's performance has continued to slide year to date. While analysts expect sales to improve and losses to narrow later this year, the company's full-year loss will probably be similar to its 2012 results.

To regain its level of sales from 2010 -- the last time the company earned more than $2 per share -- J.C. Penney will need to increase its revenue by 43% beyond its expected 2013 total. In order to accomplish that task by 2017, J.C. Penney would need to achieve a compound annual sales growth rate of more than 9%! Even the most successful department stores today are not growing that quickly.

To some observers, it appears that J.C. Penney should be able to get back to $17 billion or $18 billion in annual sales, because the company "only" has to win back the customers it lost last year. In reality, J.C. Penney's task is not so simple. Sears has seen its domestic comparable-store sales sink every year for the past decade. Total revenue peaked at $53 billion in 2006, but has plunged to less than $40 billion last year.

Weak results in one year have not made it easier for Sears to "recapture" revenue in later years. While Sears lost 25% of its revenue over six years and J.C. Penney lost that much in just one year, the two situations are quite similar. Time has passed these retailers by, and it's unrealistic to hope for more than modest sales growth going forward.

A short lease on life
J.C. Penney recently closed on a $2.25 billion term loan with Goldman Sachs (NYSE: GS  ) . This gives the company much-needed liquidity, but longer term, this deal looks more likely to be an anchor than a solution for J.C. Penney. The loan will reportedly bear interest at LIBOR plus 5 percentage points, with a LIBOR floor of 5%. Thus, the interest rate will be a minimum of 6%, meaning that J.C. Penney will be on the hook for annual interest payments of $135 million.

This loan will allow J.C. Penney to repay the $850 million it recently drew from its credit line, and it has also been used to pay off almost $250 million of debentures at a substantial premium to face value. These two actions will leave a little more than $1 billion to cover operating losses.

However, J.C. Penney did not generate any operating cash flow in 2012 -- and is on pace for a similar performance in 2013 -- yet the company plans to invest $1 billion in capital expenditures this year . In other words, the $1 billion cushion created by the recent loan transaction will only cover one year of negative free cash flow. After that, the company will need to raise more capital or dip into its revolving credit line again if free cash flow remains negative. This would lead to even higher interest payments, aggravating the company's losses.

Summing it up
The J.C. Penney of today reminds me a lot of Rite Aid (NYSE: RAD  ) a few years ago. While Rite Aid has made a bit of a comeback in the last few years, it is struggling under a mountain of debt -- totaling roughly $6 billion -- that perennially hamstrings its profitability. As a result, Rite Aid's equity is worth just 31% of the company's total enterprise value (the other 70% represents the value of the company's debt). To put it another way, the company is always one wrong step away from a trip to bankruptcy court.

J.C. Penney could face the same situation in five years. Even if Mike Ullman manages to win back lots of customers over that time period and the company approaches 2010 levels of operating profit, it may need to take out billions of dollars in debt to keep the ship afloat until then. That will burden the company with hundreds of millions of dollars in annual interest payments.

Any delay in returning to profitability would just add to those interest payments. As a result, J.C. Penney's short-term problems have serious long-term implications. Its turnaround attempt may be an interesting story to watch over the next few years, but it's not a good investment candidate. Given the company's rapid cash burn and heavy debt load, any further mistakes could quickly send J.C. Penney into bankruptcy.

J.C. Penney's stock cratered under Ron Johnson's leadership, but could new CEO Mike Ullman present the opportunity investors have been waiting for? If you're wondering whether J.C. Penney is a buy today, you're invited to claim a copy of The Motley Fool's must-read report on the company. Learn everything you need to know about JCP's turnaround -- or lack thereof. Simply click here now for instant access.


Read/Post Comments (11) | Recommend This Article (17)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 19, 2013, at 10:37 AM, Tjrbnn wrote:

    Amazing 2 men can bring down a company this size, Ackman and his greed, Ronnie and his ego. My take too JCP is too far gone. The lost of its core customers, some just due to Ron's mouth calling and labeling them "old ladies", the Stewart trial, entitlement to skip on building permits, not paying contractors, a lawsuit the JCP ripped off the new LOGO, the Bangladesh building, the list goes on, most likely alienated this group which had more collectedly had midAmerica heartland values then old ladies values, something Ron couldn't see because of being born with a silver spoon in his mouth. This group provided the glue income as did those gutted in-house brands. Most of this group is gone forever. Bring back some of those in-house brands isn't going to help, they have the image of being cheaper made then before, Joe Fresh being made for an in-house Canadian Walmart like grocery store doesn't help. Shoppers now think Walmart while shopping across the board, the problem, Walmart does have everyday prices. The miss use of that 4 dollar per square foot advance that JCPenny had was destroyed in those areas Ron was allowed to change and Ullman was locked into for the long term. That "Home" area will be the "added" shoppers experience that will being JCP down. Too few choices, too few pieces of open stock displayed, I counted 160 in that Conran section, massive wasted floor space because of the use of vertical rather than horizon space, these sections look like you need someone to pull the item from stock, i.e. they are not storing the boxed items in the display area, too little change in items offered because they are "design" by someone. This isnt going to wear well, you seem to need a Team Member for this, good luck finding a live JCP employee, this area looks like a cemetry. You have 1 teakettle, 1 coffee pot, 1 walfle iron design under Conran, how many of these are you going to see, how often is that design going to change on that stuff? That Adler furniture looks like from the late 50s early 60s from the Dick van Dyke show, at 4-5K for one small soft this sfuff is just going to sit both on the floor, in the warehouse. JCP is on a roller coaster ride, money has been thrown at it to get it to a high peak, let go, gravity will pull it up other "hills", peaks, each less higher then the last until the ride ends. I doubt anyone will want to ride it again after getting off, customers or investors. Sometimes it is best when dealing with a retail store to walk into it with a faux, sudo shopping list and see if you would buy from it rather then anything else to see if "this vision" is going to work. It isn't, you now have two different feels in this store, the traditional store, the Brookstone feel, this is a major problem.

    I do wish I had a time machine, those reports of how coming out on how Ronnie came up with the idea of putting a food court to offer gelato, cookies, coffee, candy, free hair cuts, yoga lessons inside a JCP was an eye opener. seems it was based on his mall visits to put in Apple stores. The Anchors had the best parking, everyone was at the food court. I would question when these visits occurred? Given what I can tell from the hours kept at home office, Mon-Thurs 10 Am ish thru maybe 3 PM? If so, guessing, neatly this info was missing from the genius, not the best sampling of data, now is it? But then Ron went with gut feelings. cheesy eyeball data collecting, no testing those theories derived from those gut conclusions from what I can tell. Stay with JCP? Buy a lottery ticket your odds for any kind of gain is a lot greater, based on my gut feeling, shooting from the hip.

  • Report this Comment On June 19, 2013, at 3:19 PM, tundrowalker wrote:

    JCP has done a lot wrong lately. But, they have the potential to turn-around. I think Macy's is a bit over-priced for the middle-class ladies. Kohls has eaten a lot of JCP's lunch, and JCP needs to do whatever it can to be a cross-breed of Macy's and Kohls going fwd. They need to ditch the brands catering to broke 20-somethings and poor house wives, and start catering to the middle-class working women "old ladies" that Ron ran off. That was their bread and butter. They need to stop remodeling the stores to look cheap and cheesy, too. Everything they did was turning the store into a cheesy, low-class 20-something dumping ground. They ran off a solid demographic to trying to bring in a broke demographic. They apologized to customers, are bringing back sales. But, they need to seriously turn everythign else around. Bring back their name brands. STOP buying made-in-china cheap junk that tears up after 3 washings. If folks want cheap junk, they can shop at Wal Mart. JCP can potentially turn things around, but they need to seriously start kissing up to the middle-class working women again.

  • Report this Comment On June 19, 2013, at 3:23 PM, tundrowalker wrote:

    I guess I forgot to add that I think JCP can fill a gap between Macy's and Kohls. The problem is that JCP is dying on the vine b/c they stuck with Malls. Malls are dead, and most are turning into cheap-o flea markets. Sears and JCP are both dying, b/c Malls attract poor folks these days with the flea market shops that are opening up in the atrium areas. Look around at the mall. See how many made-in-china cheap-o goods stores are selling lucky bamboo and waving cat statues. That's all flea market junk. Malls shot everyone in the foot by charging too much for retail space. This ran off folks like Macy's and made Kohls avoid the Mall to begin with. Both Kohls and Macys are successful, b/c they're building their own stores in new outdoor mall areas. They noticed that outlet stores were popular, but some folks thought outlet stores were "ghetto". So, they grouped together with other popular stores to make outdoor malls. JCP & Sears are dying on the vine, b/c they stuck with Malls. They need to rethink that strategy in a big way.

  • Report this Comment On June 21, 2013, at 6:59 PM, TMFGemHunter wrote:

    Thanks for the comments. I agree that one of J.C. Penney's problems is that it is heavily concentrated in malls. But the real killer is that relatively few are in A-grade malls. There are plenty of dept. stores from Macy's on up that have lots of mall stores, but they tend to be in fancier malls with a wealthier clientele.

    Unfortunately, J.C. Penney is sort of stuck with its strategy. It would be pretty costly to close a lot of the mall stores and open up freestanding stores instead.

    All that said, the mall problem was manageable, and the company was profitable just a few years ago. But it has been horribly mismanaged since then.

    Adam

  • Report this Comment On June 22, 2013, at 12:49 PM, TerryHogan wrote:

    The old ladies don't shop enough, and those that do have money to spend shop at Talbot's, Chico's, or higher end Nordstom's etc. The young ones aren't interested in JC Penney period. And the middle aged ones are at Wal-Mart or Target. This is a dog in the long-term. Way too much competition in this space, and they have no niche to fit into.

  • Report this Comment On June 22, 2013, at 1:40 PM, Eternallegs wrote:

    JCP in the mall I shop in must WANT to shut down. I have never seen so many rude, uncaring, irritated sales personnel ever. They do NOT want to help you, they turn away if you look like you might have a question and they will literally IGNORE you standing at their counter...LITERALLY this has been my experience, so since I love their clothes and can't endure their rude sales people I just STOPPED shopping there.

  • Report this Comment On June 22, 2013, at 11:54 PM, mystery192 wrote:

    not only the financials.. but we need to consider a formiadable rival like Macy's as well. Many of my friends who shop at Macy's just love the store and are hooked forever. JCP lost majority of its customers to Macy's (which is very well positioned and has won hearts of customers). It is very difficult to get them back.

    I had worked on my parents shop for 13 years and my dad has done retailing all his life. He taught me one basic , the most important thing is to get a customer to the store, and then ensure a sale happens ( if customer is happy he will automatically come back). Once a customer's foot get used to a shop or store, he is very less likely to go somewhere else. I have seen that with myself. We are so used to go to Macy's valley fair store that, leave any other retailer aside, even other Macy's store doesn't look great to us.

    i think its an uphill task for JCP to get those lost customers back

  • Report this Comment On June 23, 2013, at 1:25 PM, sikiliza wrote:

    JCP will waddle along like a zombie for years to come, taking opportunistic debt injections along the way until we all wake up one day and find bankruptcy reports all over the place.

  • Report this Comment On June 23, 2013, at 5:47 PM, Plan2Prosper wrote:

    Could you please clarify the interest rate comment leading the "a short lease on life" section?

    I may be missing something, but if the LIBOR floor is 5% and you add a 5 percentage points on top, that sounds like a 10% rate minimum rather than the 6% mentioned.

    Thanks!

  • Report this Comment On June 23, 2013, at 8:01 PM, TMFGemHunter wrote:

    @Plan2Prosper: Thanks for pointing that out; somehow a typo crept into the article. The LIBOR floor is 1%, not 5% as written in the article. I will submit a correction.

    Adam

  • Report this Comment On June 23, 2013, at 8:08 PM, TMFGemHunter wrote:

    @sikiliza: I think JCP has just about reached the end of the string in terms of debt offerings. The company has now pledged nearly all of its assets for its various debt offerings and the credit line. With the financials as bad as they are, JCP probably could not get unsecured debt on any sort of reasonable terms.

    There's still the revolving credit line; I'm assuming that J.C. Penney will pay that back with the proceeds of the recent bond offering. The revolver could provide around $2 billion in an emergency. That could keep the company going a few more years, but by then the writing would be on the wall.

    Adam

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2495462, ~/Articles/ArticleHandler.aspx, 10/24/2014 2:20:31 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated Moments ago Sponsored by:
DOW 16,762.44 84.54 0.51%
S&P 500 1,960.77 9.95 0.51%
NASD 4,471.02 18.22 0.41%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

10/24/2014 2:04 PM
JCP $7.66 Down -0.07 -0.91%
J.C. Penney Compan… CAPS Rating: *
GS $182.66 Up +2.60 +1.44%
Goldman Sachs CAPS Rating: ****
RAD $4.77 Down -0.09 -1.83%
Rite Aid Corp CAPS Rating: ***
SHLD $40.01 Up +4.06 +11.29%
Sears Holdings CAPS Rating: *

Advertisement