J.C. Penney (JCPN.Q) has been underperforming for years, but the iconic department store chain has taken a turn for the worse in 2018. The company has struggled with poor inventory management all year, and comp sales trends turned negative last quarter.
This worrisome situation led former Walmart CEO Bill Simon to speculate recently that J.C. Penney might not survive to the next holiday season -- at least not as an independent company. But while J.C. Penney is in trouble, it's extremely unlikely that it will disappear anytime soon.
J.C. Penney is not the same as Bon-Ton or Sears
Between 2015 and 2017, U.S. department stores faced weak sales trends as consumers cut back on trips to the mall in favor of the convenience of e-commerce. Yet this persistent weakness in the department store sector didn't lead to any bankruptcies -- until this year.
Bon-Ton filed for bankruptcy in February and was eventually forced to liquidate. Its last stores closed in August. Meanwhile, Sears Holdings finally ran out of ways to stave off bankruptcy. It filed for protection from its creditors in October, and while it hopes to keep 400 or 500 stores operating beyond 2019 -- down from about 1,000 earlier this year -- even that may be asking too much.
On the surface, J.C. Penney might seem to be just months behind these peers. After all, it loses money fairly consistently and has far too much debt.
Yet there are some important differences. Most notably, J.C. Penney has been producing positive free cash flow every year despite its recent troubles. It expects free cash flow to remain positive this year, and its current push to dramatically reduce inventory will give its cash flow a further boost in 2019. By contrast, Sears has consistently burned at least $1.5 billion of cash annually in recent years. And while Bon-Ton was closer to achieving positive free cash flow, it lacked the critical mass to be a viable company.
High debt basically rules out an acquisition
In his interview with Fox Business, Simon seemed to suggest that J.C. Penney might become an acquisition target if it were to have a bad holiday season. Indeed, the company's market cap has fallen to around $400 million, which might make buying it seem like a cheap way for a competitor to expand.
However, any potential acquirer would have to deal with J.C. Penney's debt load, which stands around $4 billion today. That means that acquiring J.C. Penney would be expensive, even if the company's share price falls even further due to weak holiday-season results. It's highly unlikely that anyone would be interested in paying billions of dollars (including debt assumption) to buy an unprofitable retailer that seems to have lost touch with its customers.
There's room to maneuver
Of course, the other way that J.C. Penney could disappear before Black Friday of 2019 would be a liquidation of its own. That prospect seems equally unlikely.
First, J.C. Penney ended last quarter with over $1.9 billion of liquidity, and it has minimal debt maturities until 2023. Considering that it is starting from positive free cash flow, even a sharp downturn in its business probably wouldn't put it on the verge of bankruptcy for several years.
Second, J.C. Penney's management recently laid out some simple ways to improve the company's profitability even without returning to sales growth. Just by managing its inventory better so that it can sell clearance merchandise at break-even gross margins or better (as it did just a few years ago) and cracking down on theft, J.C. Penney could boost earnings by hundreds of millions of dollars annually.
New CEO Jill Soltau will need to get J.C. Penney's sales growing again to keep the company in business for the long run. But even if she is unable to turn the storied retailer around, J.C. Penney is likely to stumble on for several more years -- and possibly even longer.