Despite the Huge Rally, J.C. Penney Isn't Out of the Woods

Source: Wikimedia Commons

General merchandise retailer J.C. Penney (NYSE: JCP  ) has been to the brink of collapse and back again. It's gone through a business restructuring, the unceremonious exit of a high-profile chief executive officer, and saw its sales fall off a cliff in just a few years.

After reporting first-quarter earnings, all of that seems to be a distant memory. Shares of J.C. Penney skyrocketed after a surprise increase in same-store sales. There seems to be a sense of euphoria that the company may finally have found a floor and that a meaningful turnaround could truly materialize.

It's certainly the case that J.C. Penney posted solid growth on the surface. But the company is by no means out of the woods. It's being given the benefit of the doubt for mere survival, which hardly seems like reason to celebrate. Only the most risk-tolerant investors should consider J.C. Penney because the company still faces a host of risks. If you're interested in a department store, you'd be better off buying Macy's  (NYSE: M  ) .

Rewarded for survival
J. C. Penney shares soared after earnings were announced. While that might lure you into thinking the company is on the cusp of a return to greatness, that doesn't appear to be the case. J. C. Penney's 16% spike post-earnings looks simply like a relief rally amid massive short-covering. The company's underlying results were ugly and shouldn't inspire any confidence.

Its performance was better than feared, and the market essentially rewarded the company for lasting through another quarter. In all, comparable-store sales, which measure sales at locations open at least one year, rose 6.2%, which looks good. But it's important to note the extremely easy comparisons J.C. Penney faced. Put simply, the company's sales fell off a cliff for the past few years, which means going forward, it will enjoy the benefit of a very low base.

Despite its sales growth on a percentage basis, J.C. Penney's first-quarter total sales of $2.8 billion were still well below the revenue generated just a few years ago. Consider that J.C. Penney generated $3.9 billion in sales in the first quarter of 2011. That means that its sales have fallen 29% over the past three years.

In addition, J.C. Penney is still spending a lot of money on its restructuring. Elevated costs have eroded margins in that time frame as well. Three years ago, J.C. Penney's gross margin clocked in at 40.5%. The gross margin now stands at 33.1%, representing more than a 7 percentage point deterioration in margins.

Despite its rise in sales, J.C. Penney is no more profitable than it was last year. In fact, it actually lost more money in the first quarter of 2014 than it did in the first quarter last year. The company's net loss expanded to $352 million from $348 million, year over year.

J.C. Penney is still losing a lot of money, and better alternatives exist among department stores. For example, Macy's is solidly profitable, has demonstrated much more consistent growth over the past few years, and pays a dividend.

Macy's gross margin is 40%, and its diluted earnings per share are up 32% since 2011. To reflect its success, the company has increased its dividend five-fold in that time span.

No need to take the risk
The key takeaway is that while it may seem like J.C. Penney is finally out of the woods, proper context is necessary. Its huge rally after releasing earnings seemed more like a relief rally based on short covering rather than the beginnings of a real turnaround.

J.C. Penney was less profitable in the first quarter than it was in the year-ago period. It pays no dividend and offers very little downside risk. By contrast, Macy's is growing reliably and rewards its shareholders with solid profits and a dividend. There's simply no need to risk your money on J.C. Penney's questionable outlook when better, more profitable alternatives exist.

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  • Report this Comment On May 23, 2014, at 9:46 AM, Matt8265 wrote:

    Lost 550m in 2013. Used a 200 million tax credit.

  • Report this Comment On May 23, 2014, at 2:12 PM, longjcptoppick wrote:

    J.C. Penney: In The Long Term, A Lot More Room To Run and will pass Macy's.

    May. 22, 2014 11:33 AM ET | 48 comments | About: J.C. Penney Company Inc. (JCP)

    Disclosure: I am long JCP. (More...)

    Summary

    JCP's operations are beginning to hum.

    The sell-side and buy-side are not yet on board which is their mistake.

    The long-term free cash flow generating ability of the Company should be worth much more.

    I continue to be amazed at how J.C. Penney (JCP) the stock trades compared to JCP the business. Since the stock offering in the fall, the Company has stabilized and now grown comps in the face of severe industry headwinds, brought back private label and promotions which have improved margins, and guided to FCF neutral on the year. All of this in the face of a brutal retail environment. Bon-Ton Stores (BONT) by contrast just reported another weak quarter though they did manage 35%+ gross margins which is where JCP is headed this year as well if not better. JCP debt has responded by rocketing to the highs while the stock is well off its lows, it continues to trade well below the $9.65 offer price and the intrinsic value.

    20,236 people received this article by email alert

    Add your email to get alerts on JCP too:

    Get email alerts on JCP »

    Why the disconnect? I do believe that CEO, Mike Ullman, bears some of the blame. While I can not argue with his operational success if not genius in rapidly reversing the nosedive under Ron Johnson and credit the board for bringing him back in the face of withering criticism from Ackman, who resigned from the board and sold his stock over the issue of CEO control (among other things), I can fault Ullman's ability to manage the street and his stock price. From the ham-handed way the offering was handled to the two line holiday same store sales release that panicked investors that Christmas was a disaster when in reality it was on plan and one of the best showing of any department store chain. The 6-7% comp. in Q1 simply blew away expectations and left the bears scrambling for ways to knock the stock down. If Ullman is to be the permanent CEO, he must do more to manage investors and his stock price or he should go.

    Here is where the story gets interesting. The bears have been mostly using static analysis to say J.C. Penney was going bankrupt. There last two quarters and FCF neutral guide for year end tell you that is just not going to happen. A new credit line with an extra $500mm also tells you that equity dilution is far less likely if not a zero possibility. For most of the time since I started posting on JCP after the offering, the bears have been saying that Chapter 11 or massive dilution was inevitable and that JCP was stuck at $12 billion in sales and low 30s gross margins, never mind that every comp does mid to high 30s and that sales were $17 billion before Ron Johnson came on board.

    One thing to beware from the sell side and buy side commentators is a shift in story. The facts have clearly changed as even the most hardened bear will say that J.C. Penney is on the mend. The bear argument has now shifted to one of valuation which is a slippery slope since JCP is very cheap to its long-term earning power. Two of the biggest bears, Wells and Imperial are essentially using this argument to help the shorts and intercapital arbs cover in a bad macro tape at levels that are too cheap to be believed. For the last several quarters, Wells has been using JCP's good numbers and contorting the facts to say the Company is really still going bankrupt. Now that his theory has been blown out of the water (q4 and q1 results plus a 20 point drop in 5 year CDS to the mid teens from the mid 30s shows just how wrong Wells has been), the analyst has shifted to saying that the stock is overvalued. Valuation is more of an art and a science, but JCP appears to be on track to undo most of not all of the RJ damage. I am even running scenarios where the company actually gets to higher than $17 billion in sales, as it takes share from Sears (SHLD), Kohl's (KSS), Macy's (M) and BONT.

    What would a back to the future JCP look like? If JCP were to get back to $17 billion in sales and 39% margins which is where it was under Ullman before the RJ debacle (assuming no additional growth from the economy as they recapture share) and were able to keep SGA around $4 billion (it was bloated before that is one thing RJ got right and Ullman has continued), EBITDA goes to the $2.6 billion to $2.7 billion range by 2016. The Company pays off most if not all of its debt by then. A modest 6x multiple yields about $50 a share. If one looks at pretax free cash flow, the Company would generate about $7.35 a share, 10x that number is $75 for the stock. That is the money that the long-term bulls are playing for.

    I think this can happen by 2016, which gives Ullman 3-4 years. If it takes longer so be it, but the point I would make is as long as we are fcf neutral we have unlimited time for this to play out. Also it is obvious that JCP is taking share from bont, m, kss, shld, etc. based on the recent reports. The assumptions would be:

    Rev: 17003.308

  • Report this Comment On May 23, 2014, at 2:14 PM, longjcptoppick wrote:

    I also see JCP passing M...

    for some reason bashers like Motleys Fools Always bashing for money.. wonder when SEC will crack down on Motleys and arrest and fine them for bashing and pumping M...

    I too see JCP higher than M this year..

  • Report this Comment On May 28, 2014, at 6:49 AM, longjcptoppick wrote:

    J.C. Penney: In The Long Term, A Lot More Room To Run

    May. 22, 2014 11:33 AM ET | 90 comments | About: J.C. Penney Company Inc. (JCP)

    Disclosure: I am long JCP. (More...)

    Summary

    JCP's operations are beginning to hum.

    The sell-side and buy-side are not yet on board which is their mistake.

    The long-term free cash flow generating ability of the Company should be worth much more.

    I continue to be amazed at how J.C. Penney (JCP) the stock trades compared to JCP the business. Since the stock offering in the fall, the Company has stabilized and now grown comps in the face of severe industry headwinds, brought back private label and promotions which have improved margins, and guided to FCF neutral on the year. All of this in the face of a brutal retail environment. Bon-Ton Stores (BONT) by contrast just reported another weak quarter though they did manage 35%+ gross margins which is where JCP is headed this year as well if not better. JCP debt has responded by rocketing to the highs while the stock is well off its lows, it continues to trade well below the $9.65 offer price and the intrinsic value.

    20,279 people received this article by email alert

    Add your email to get alerts on JCP too:

    Get email alerts on JCP »

    Why the disconnect? I do believe that CEO, Mike Ullman, bears some of the blame. While I can not argue with his operational success if not genius in rapidly reversing the nosedive under Ron Johnson and credit the board for bringing him back in the face of withering criticism from Ackman, who resigned from the board and sold his stock over the issue of CEO control (among other things), I can fault Ullman's ability to manage the street and his stock price. From the ham-handed way the offering was handled to the two line holiday same store sales release that panicked investors that Christmas was a disaster when in reality it was on plan and one of the best showing of any department store chain. The 6-7% comp. in Q1 simply blew away expectations and left the bears scrambling for ways to knock the stock down. If Ullman is to be the permanent CEO, he must do more to manage investors and his stock price or he should go.

    Here is where the story gets interesting. The bears have been mostly using static analysis to say J.C. Penney was going bankrupt. There last two quarters and FCF neutral guide for year end tell you that is just not going to happen. A new credit line with an extra $500mm also tells you that equity dilution is far less likely if not a zero possibility. For most of the time since I started posting on JCP after the offering, the bears have been saying that Chapter 11 or massive dilution was inevitable and that JCP was stuck at $12 billion in sales and low 30s gross margins, never mind that every comp does mid to high 30s and that sales were $17 billion before Ron Johnson came on board.

    One thing to beware from the sell side and buy side commentators is a shift in story. The facts have clearly changed as even the most hardened bear will say that J.C. Penney is on the mend. The bear argument has now shifted to one of valuation which is a slippery slope since JCP is very cheap to its long-term earning power. Two of the biggest bears, Wells and Imperial are essentially using this argument to help the shorts and intercapital arbs cover in a bad macro tape at levels that are too cheap to be believed. For the last several quarters, Wells has been using JCP's good numbers and contorting the facts to say the Company is really still going bankrupt. Now that his theory has been blown out of the water (q4 and q1 results plus a 20 point drop in 5 year CDS to the mid teens from the mid 30s shows just how wrong Wells has been), the analyst has shifted to saying that the stock is overvalued. Valuation is more of an art and a science, but JCP appears to be on track to undo most of not all of the RJ damage. I am even running scenarios where the company actually gets to higher than $17 billion in sales, as it takes share from Sears (SHLD), Kohl's (KSS), Macy's (M) and BONT.

    What would a back to the future JCP look like? If JCP were to get back to $17 billion in sales and 39% margins which is where it was under Ullman before the RJ debacle (assuming no additional growth from the economy as they recapture share) and were able to keep SGA around $4 billion (it was bloated before that is one thing RJ got right and Ullman has continued), EBITDA goes to the $2.6 billion to $2.7 billion range by 2016. The Company pays off most if not all of its debt by then. A modest 6x multiple yields about $50 a share. If one looks at pretax free cash flow, the Company would generate about $7.35 a share, 10x that number is $75 for the stock. That is the money that the long-term bulls are playing for.

    I think this can happen by 2016, which gives Ullman 3-4 years. If it takes longer so be it, but the point I would make is as long as we are fcf neutral we have unlimited time for this to play out. Also it is obvious that JCP is taking share from bont, m, kss, shld, etc. based on the recent reports. The assumptions would be:

    Rev: 17003.308

    Gross Profit:6631.29

    SGA: 4000

    Net Debt: 0

    Multiple: 6x EV/EBITDA

    With 400mm of cap-ex, should generate about 7.35 of FCF per share This is why stock was in 30s even before Ackman.

    Bears will say that is impossible given where they are now, but bears have been calling for negative comps and near term bankruptcy and that looks silly now. These numbers are really just getting back to what JCP did under Ullman a few years ago with a lot of debt pay down and some SGA improvement and capital efficiency that they have already shown able to do. Who is really being more unrealistic? These numbers aren't even that exciting, what if JCP actually gets some of the sales productivity that Johnson and Ackman were dreaming of when they bought the stock in the 20s and 30s? Much higher numbers are possible.

  • Report this Comment On May 28, 2014, at 6:49 AM, longjcptoppick wrote:

    EVERYONE REPORT MOTLEYS FOOLS.. PAID BASHER.. BASHES JCP.. and PUMPS UP MACYS ALWAYS...

    J.C. Penney: In The Long Term, A Lot More Room To Run

    May. 22, 2014 11:33 AM ET | 90 comments | About: J.C. Penney Company Inc. (JCP)

    Disclosure: I am long JCP. (More...)

    Summary

    JCP's operations are beginning to hum.

    The sell-side and buy-side are not yet on board which is their mistake.

    The long-term free cash flow generating ability of the Company should be worth much more.

    I continue to be amazed at how J.C. Penney (JCP) the stock trades compared to JCP the business. Since the stock offering in the fall, the Company has stabilized and now grown comps in the face of severe industry headwinds, brought back private label and promotions which have improved margins, and guided to FCF neutral on the year. All of this in the face of a brutal retail environment. Bon-Ton Stores (BONT) by contrast just reported another weak quarter though they did manage 35%+ gross margins which is where JCP is headed this year as well if not better. JCP debt has responded by rocketing to the highs while the stock is well off its lows, it continues to trade well below the $9.65 offer price and the intrinsic value.

    20,279 people received this article by email alert

    Add your email to get alerts on JCP too:

    Get email alerts on JCP »

    Why the disconnect? I do believe that CEO, Mike Ullman, bears some of the blame. While I can not argue with his operational success if not genius in rapidly reversing the nosedive under Ron Johnson and credit the board for bringing him back in the face of withering criticism from Ackman, who resigned from the board and sold his stock over the issue of CEO control (among other things), I can fault Ullman's ability to manage the street and his stock price. From the ham-handed way the offering was handled to the two line holiday same store sales release that panicked investors that Christmas was a disaster when in reality it was on plan and one of the best showing of any department store chain. The 6-7% comp. in Q1 simply blew away expectations and left the bears scrambling for ways to knock the stock down. If Ullman is to be the permanent CEO, he must do more to manage investors and his stock price or he should go.

    Here is where the story gets interesting. The bears have been mostly using static analysis to say J.C. Penney was going bankrupt. There last two quarters and FCF neutral guide for year end tell you that is just not going to happen. A new credit line with an extra $500mm also tells you that equity dilution is far less likely if not a zero possibility. For most of the time since I started posting on JCP after the offering, the bears have been saying that Chapter 11 or massive dilution was inevitable and that JCP was stuck at $12 billion in sales and low 30s gross margins, never mind that every comp does mid to high 30s and that sales were $17 billion before Ron Johnson came on board.

    One thing to beware from the sell side and buy side commentators is a shift in story. The facts have clearly changed as even the most hardened bear will say that J.C. Penney is on the mend. The bear argument has now shifted to one of valuation which is a slippery slope since JCP is very cheap to its long-term earning power. Two of the biggest bears, Wells and Imperial are essentially using this argument to help the shorts and intercapital arbs cover in a bad macro tape at levels that are too cheap to be believed. For the last several quarters, Wells has been using JCP's good numbers and contorting the facts to say the Company is really still going bankrupt. Now that his theory has been blown out of the water (q4 and q1 results plus a 20 point drop in 5 year CDS to the mid teens from the mid 30s shows just how wrong Wells has been), the analyst has shifted to saying that the stock is overvalued. Valuation is more of an art and a science, but JCP appears to be on track to undo most of not all of the RJ damage. I am even running scenarios where the company actually gets to higher than $17 billion in sales, as it takes share from Sears (SHLD), Kohl's (KSS), Macy's (M) and BONT.

    What would a back to the future JCP look like? If JCP were to get back to $17 billion in sales and 39% margins which is where it was under Ullman before the RJ debacle (assuming no additional growth from the economy as they recapture share) and were able to keep SGA around $4 billion (it was bloated before that is one thing RJ got right and Ullman has continued), EBITDA goes to the $2.6 billion to $2.7 billion range by 2016. The Company pays off most if not all of its debt by then. A modest 6x multiple yields about $50 a share. If one looks at pretax free cash flow, the Company would generate about $7.35 a share, 10x that number is $75 for the stock. That is the money that the long-term bulls are playing for.

    I think this can happen by 2016, which gives Ullman 3-4 years. If it takes longer so be it, but the point I would make is as long as we are fcf neutral we have unlimited time for this to play out. Also it is obvious that JCP is taking share from bont, m, kss, shld, etc. based on the recent reports. The assumptions would be:

    Rev: 17003.308

    Gross Profit:6631.29

    SGA: 4000

    Net Debt: 0

    Multiple: 6x EV/EBITDA

    With 400mm of cap-ex, should generate about 7.35 of FCF per share This is why stock was in 30s even before Ackman.

    Bears will say that is impossible given where they are now, but bears have been calling for negative comps and near term bankruptcy and that looks silly now. These numbers are really just getting back to what JCP did under Ullman a few years ago with a lot of debt pay down and some SGA improvement and capital efficiency that they have already shown able to do. Who is really being more unrealistic? These numbers aren't even that exciting, what if JCP actually gets some of the sales productivity that Johnson and Ackman were dreaming of when they bought the stock in the 20s and 30s? Much higher numbers are possible.

  • Report this Comment On May 28, 2014, at 7:19 AM, dbtheonly wrote:

    longjcp certainly has had an interesting conversation. Glad he cites his being long. One might take it for a pump otherwise.

    The key question for the true long term is whether JCP, or any retailer, has a future in the world of internet sales.

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