J.C. Penney Company, Inc. Is 1 Step Closer to Bankruptcy

On Tuesday, J.C. Penney  (NYSE: JCP  ) issued a press release stating that comparable-store sales for the troubled department store operator rose approximately 2% last quarter. That marks the company's first comparable-store sales growth in more than two years. CEO Mike Ullman proclaimed that "the steady improvements in our business show that the Company's turnaround is on track."

J.C. Penney's CEO claims that the "turnaround is on track."

Investors shouldn't take that declaration at face value. In fact, J.C. Penney is in big trouble. Based on its current sales momentum -- or the lack thereof -- J.C. Penney is more likely than ever to seek bankruptcy protection within the next year or two.

The bigger picture
While J.C. Penney bulls will be happy to see any level of sales growth, the company's 2% gain last quarter was not enough to improve the company's long-term health.

First of all, J.C. Penney had reported in early December that comparable-store sales grew 10.1% in November. The latest update implies that comparable-store sales must have declined in both December and January. In other words, J.C. Penney's big Thanksgiving weekend deals pulled sales forward into the month of November more than they stimulated additional spending.

Additionally, J.C. Penney faced its easiest year-over-year comparison last quarter. The company did not offer significant holiday promotions in Q4 of 2012, causing a 31.7% drop in comparable-store sales that quarter.

J.C. Penney's meager sales growth last quarter means that it regained only a small fraction of the revenue it lost in the previous year. Put a different way, J.C. Penney's Q4 comparable-store sales are still down nearly 30% since 2011 -- when the company was already barely profitable.

Liquidity problems ahead
J.C. Penney's ongoing poor performance puts the company on a path toward severe liquidity issues later this year, which could intensify further in 2015 -- if the company gets that far. J.C. Penney achieved its goal of ending the 2013 fiscal year with more than $2 billion of liquidity (cash and investments plus a credit line), but that shouldn't give investors much comfort.

The problem is that J.C. Penney burned $3 billion of cash through the first three quarters of its recently concluded fiscal year. In other words, at last year's rate, J.C. Penney would be out of cash by the fall.

In reality, J.C. Penney's situation isn't quite that dire. The company increased its inventory level during 2013 in order to improve in-stock levels and expand its private-label selection. It also spent an unusually high amount on capital expenditures to remodel its stores. Without these unusual expenditures, J.C. Penney's cash burn would have been around $2 billion for the first three quarters of last year.

Nevertheless, without a substantial improvement in J.C. Penney's revenue and gross margin trends, the company will be dangerously short of liquidity by the fall. Suppliers may be reluctant to provide holiday goods on credit if the company seems to be on shaky ground, which would further aggravate the problem. In short, if comparable-store sales growth of 2% is the best J.C. Penney can manage, the company could hit a crisis point before the end of the year.

What next?
Obviously, the best solution for J.C. Penney would be a miraculous rebound in sales and gross margin to stabilize free cash flow. However, even after its ongoing cost cuts, J.C. Penney would probably need its sales to rebound to $14 billion annually to break even on a cash flow basis. That would imply a more than 15% jump in sales, something that seems increasingly unlikely.

Barring an immediate bounce in operating performance, the second-best option for J.C. Penney would be significant asset sales. (The company raised a lot of debt and equity in 2013, and it would be difficult or impossible to convince investors to hand over any more cash through another debt or stock sale.)

However, J.C. Penney has been selling off non-core assets in a piecemeal fashion for two years, so there probably is not much left of value aside from its headquarters and store real estate. Moreover, J.C. Penney mortgaged most of its real estate assets last year as collateral for a $2.25 billion term loan. Even if it did sell off real estate, a significant part of the proceeds would have to go toward paying off that debt, rather than bolstering the company's liquidity.

Moving closer to bankruptcy
Given the pace of J.C. Penney's cash burn and the lack of other financing alternatives, filing for bankruptcy may be the only option if conditions don't improve soon.

That wouldn't necessarily mean the end of J.C. Penney. A bankruptcy restructuring could buy J.C. Penney some extra time to reduce its costs and hopefully win back customers. Bankruptcy would also give the company an opportunity to restructure its debt, which would reduce interest expense and lower its break-even point to a more manageable level.

However, J.C. Penney shareholders would get little or nothing in a bankruptcy proceeding, as the company's unsecured debt holders would be compensated for their losses with stock in the reorganized company. As a result, investors should continue to steer clear of J.C. Penney.

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Read/Post Comments (14) | Recommend This Article (15)

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 February 06, 2014, at 9:56 AM, longjcptoppick wrote:

    MOTLEYS fool is a paid BASHER for MACY beware.. that JCP has the same ceo that turned macy around and now doing it to JCP.. jcp best buy and will pass MACY.. IGNOR MOTLEYS FOOLS.. they really desperate.. LONG JCP FROM HERE

  • Report this Comment On February 06, 2014, at 9:57 AM, longjcptoppick wrote:

    JCP way way undervalued and better than macy..

    long jcp.. see $45.00 coming beating inline est.

    got to be long from here.. worst baked in.. and best from here.. jcp

  • Report this Comment On February 06, 2014, at 10:25 AM, Triquel wrote:

    Yes, I am getting tired of the bad news stories manipulating the stock price. Macy's announces layoffs and store closings and the stock goes up. JCP announces store closures and layoffs and it is a sign of deep trouble, the stocks go down. Even though the reasons are similar in both cases. There seems to be some sort of competition to be the first commentator to say 'I told you so' even though they are helping to create the negativity that drives the value down.

  • Report this Comment On February 06, 2014, at 11:28 AM, Franknated wrote:

    OMG! I read a lot fool.com, but hey, What's the deal with JCP???

    Does fool try what??

    JCP is 1 Step Closer to Bankruptcy?? LOL...

    1 step closer to backruptcy get fool everytime they write this stuff...

  • Report this Comment On February 06, 2014, at 11:33 AM, Stevec7 wrote:

    Thanks, Adam for your article. At first, I said to myself, probably written by some 28 year old know it all. Then I looked you up and low and behold, I was close. But all kidding aside, you may want to look into a valuation on JCP's real estate. It was conservatively valued at 4 to 6 Billion two years ago. I only specialize in retail real estate and I am bringing to your attention that JCP RE is worth between 6 and 8 billion. Look for a REIT conversion to unlock equity, effectively splitting the company into strictly retail sales and a REIT. Im not saying to buy or sell, but I am saying you are missing part of the story.

  • Report this Comment On February 06, 2014, at 11:55 AM, TMFGemHunter wrote:

    @Triquel: There's a big difference between Macy's and J.C. Penney. Namely, Macy's is making billions of dollars a year, and J.C. Penney is losing billions of dollars a year. So when Macy's closes underperforming stores, it's not the same thing as J.C. Penney closing underperforming stores.

    @Stevec7: Do you have a source for the real estate valuation?

    I did consider the issue of JCP's real estate here (and I've dealt with the subject at greater length in another article) but I don't think it will provide much incremental value. First of all, property and equipment is already on the JCP balance sheet at $5.75 billion. That's not all real estate, but a lot of the real estate value that could be unlocked would be offset by writing down store fixtures and things of that sort that won't be needed if JCP downsizes or ends retail operations.

    Second, as I mentioned above, most of the real estate is already collateral for J.C. Penney's debt.

    Third, I don't think a REIT spinoff would deliver much value to current shareholders (as opposed to new shareholders or bond investors). The problem is simply that JCP is going to be nearly out of cash in a matter of months. If you spin off the real estate, you'd have a REIT with a single tenant that's insolvent. A year or two ago, the REIT idea could have created value (a lot of people assumed that was Ackman's plan from day one when he invested back in 2011). Today, I don't think JCP is stable enough to pull it off.

    JCP is definitely looking to extract as much value as possible from its real estate though. The company just announced this morning that it is developing the vacant land near its headquarters in Plano. Not clear how much cash that could bring in, or what the timetable would be.

    Adam

  • Report this Comment On February 06, 2014, at 12:22 PM, idealab wrote:

    I found it quite profitable investing contrary to whatever the Fools writers post. When Nokia was below $3, they say that Nokia is finished, and Nokia went back to $8. When Blackberry was at $5, they say Blackberry is finished, and BB went to $10 later. Now here goes JCPenney, driven down by hypes and fear like Fools and Seeking Alpha bears. Buy JCP at $5, and watch it go to $10 a year from now.

  • Report this Comment On February 06, 2014, at 1:52 PM, Stevec7 wrote:

    @idealab, I agree MF is usually writing about what has already happened to a stock. This is common among the new generation.

    @Adam, "as you said most of the debt is collateralize by the RE". 1.75B is pledged against 6B in RE. if less than 33% is considered "most", then you have a great point. I googled "how much is JC Penney real estate worth" and I got all this information. Thanks for replying!

  • Report this Comment On February 06, 2014, at 1:54 PM, Stevec7 wrote:

    @paidbashers, I agree with you but go easy on Adam, he is only 28years old and hasnt lost his first million yet.

  • Report this Comment On February 06, 2014, at 6:37 PM, cmalek wrote:

    I'm surprised that Penney has made it this far. Around 10 years ago I used to work by a mall anchored by Macy's on one end and Penney on the other. I used to wander through bo9th stores almost daily. The difference was night and day. While Macy's clothes were sty;ish and from recognizable designers, JCPenney's were frumpy and from designers I never heard of. Even in the summer the prevalent colors were black, brown, gray, navy blue. The clothes at Tractor Supply were brighter and more stylish than at Penney's. It's high time somebody would finally put a stake through Penney's heart and put it out its misery.

  • Report this Comment On February 06, 2014, at 7:59 PM, TMFGemHunter wrote:

    We are all entitled to our own opinions. For those of you implying that I have some kind of ulterior motive, I don't have any financial interest in where J.C. Penney goes from here. For those of you who think I don't have a clue, I would point out that I started recommending that people sell J.C. Penney in November 2011 when the stock was trading for more than $30.

    Just because I was right then doesn't mean that I'm right now. But I have spent a lot of time studying JCP, and I have a pretty good idea of what's going on at the company.

    @stevec7: I just did a quick search and Cushman and Wakefield appraised the real estate value at $4 billion. I have seen higher estimates, but I've also seen lower estimates (such as a September 2013 Citi estimate that put the RE value at less than $3 billion). The Goldman term loan from earlier this year was $2.25 billion, but I also believe that some of JCP's other debt has a secondary interest in the real estate, although I'm not sure about that.

    Adam

  • Report this Comment On February 06, 2014, at 8:19 PM, MFslanderingJCP wrote:

    "...where J.C. Penney goes from here."

    Now that's funny. You and Motely Fool have relentlessly bashed JCP, especially since RJ was sent packing. You've made a joke of MF and yourself. Frankly I am surprised you don't get more grief.

  • Report this Comment On February 07, 2014, at 1:34 AM, judopick wrote:

    lately there are so many JCP bashing articles from fools. These guys are desperate to get quick money through their shorts. These guys will be in total shock within a few weeks when the stock goes to $10+...They are going to get burned if they don't cover their shorts...for a sure. It's big joke...anybody believes fools articles will be real fools..

  • Report this Comment On February 07, 2014, at 11:36 AM, FoolTheRest wrote:

    ^

    Except..."Adam Levine-Weinberg has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned."

    So does anyone who disagrees with this article (aside from Steve) have any useful counterpoints other than some version of "Adam is an idiot/paid basher/etc."?

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