Over the past two years, troubled department store operator J.C. Penney (JCPN.Q) has perfected a stunning magic trick: making cash disappear! At the end of the company's fiscal year 2010, cash and equivalents totaled more than $2.6 billion; two years later, this amount had fallen by nearly 65% to $930 million. Unfortunately for investors, the company looks set to continue running through its cash at a rapid pace for the next few quarters.

Weak free cash flow
Free cash flow is an important measure of cash generation or cash usage, as it represents the amount of cash generated (or used) by the business after accounting for investments in the business (i.e., capital expenditures). J.C. Penney regularly posted positive FCF until last year, when FCF plunged to negative $820 million.

In the first quarter of fiscal year 2012, J.C. Penney's FCF was negative $684 million. If the company posts similar results in the current quarter, cash on hand would drop to less than $250 million, which is less than ideal for a retailer of its size. (That said, J.C. Penney does have a large credit line that it can use to provide short-term liquidity.) However, it is likely that J.C. Penney's FCF performance will be even worse than last year in the current quarter.

First, J.C. Penney secured a "one-time deferral of select vendor payments" last quarter of $85 million. This $85 million was paid after the end of the fourth quarter (in early February), and will therefore reduce first-quarter cash flow by that amount. Second, J.C. Penney spent only $107 million on capex in last year's first quarter, but capex will be much higher this quarter. This is because J.C. Penney is building out 20 new "shops" this spring, primarily in the home department. This requires renovating a substantial portion of roughly 700 J.C. Penney locations. J.C. Penney expects 2013 capex to be similar to the 2012 level of $810 million, and the spring shop rollouts will put a disproportionate percentage of capex in the first quarter. I am therefore projecting capex of $300 million to $400 million this quarter. The deferred vendor payments and the increase in capex could easily reduce FCF by another $250 million compared to first-quarter 2012, leaving J.C. Penney with essentially no cash on hand by the end of the quarter.

Running out of non-core assets
In 2012, real estate was J.C. Penney's savior: The company was able to sell off various real estate assets (such as ownership interests in various malls) to produce more than $500 million cash. This helped offset the company's negative FCF. However, most of its big cash-generating opportunities have been used up, though there are still some residual opportunities, such as selling land near the J.C. Penney headquarters in Plano, Texas.

J.C. Penney could thus run through most of its remaining cash by the end of the first quarter, or shortly thereafter. Many analysts now believe that the company's next move could be selling core real estate: buildings containing active J.C. Penney stores. However, this would probably accelerate the company's demise, as the most promising locations would tend to be sold, leaving J.C. Penney with only its least desirable stores. As a result, I doubt that management would make such a decision until it has lost all hope for a turnaround. By then, it may be too late for shareholders.