More To Come From J.C. Penney
J.C. Penney (NYSE:JCP) investors are having a "Key Largo" epiphany, just like Johnny Rocco did. "Yeah. That's it. More. That's right! I want more!" gangster Rocco (Edward G. Robinson) tells Frank McCloud (Humphrey Bogart) in the film.
After shooting higher on the release of fourth-quarter results last week, JCP shares have more room to advance, we believe. Yeah. That's it. More.
We've been a fan of J.C. Penney for some time, and though our patience has been sorely tried, we simply could not help but think that the strong vein of doubt marbling the investment argument would eventually leach away and that the ore of value would reveal itself.
Convinced that the climactic quarter of fiscal 2015 would do that, we bought the shares last week at $7.50 before the release of fourth quarter results. (See our Feb. 25 instablog post, "J.C. Penney Can't Rebound? Of Course It Can, Old Sport). We argued three major points:
- 1. Holiday comp-store sales (up 3.9%) already pointed to a strong quarter.
- 2.Given JCP's strong November-December comps and the wretched performance of competitors like Macy's, market share gains should have continued apace.
- 3.Which made us think that the sales bump, if mixed with the yeast of margin gains, would bake a cake big enough to impress the doubters and rattle the considerable short positions.
We won't trouble you, gentle reader, with a rehash of the fourth quarter (you can easily find it here), but do allow us to complete our victory lap by noting that fourth-quarter comp-store sales finished with a 4.1% gain and that gross margin improved 30 basis points over the year-ago quarter to 34.1%.
By the end of trading Monday, JCP stock had appreciated 22% in two trading sessions to $10.20 per share. If you got in Wednesday, the gain was 32%. We're confident there's more to come as Penney keeps reporting progress toward its goal of $1.2 billion in EBITDA in 2017.
Looking ahead, Penney executives said on the conference call that margin expansion isn't over. "We expect continued improvement … from increased penetration and improved margin in private brands, continued improvement in our clearance profitability and as (CEO) Marvin (Ellison) discussed, benefits associated with systems utilization, supply chain efficiency and pricing analytics," remarked Edward Record, chief financial officer.
The company said it expects $1 billion in EBITDA in 2016 and positive earnings per share on a GAAP basis at some point during the year.
Valuation
We believe the shares can advance into at least the mid-teens. Our outlook is based on investors eventually assigning a price-to-sales ratio commensurate with rivals. JCP shares are currently valued at 0.25 on a price-to-sales basis, compared with 0.49 for Macy's and 0.45 for Kohl's.
To be sure, Penney looks rich on enterprise value-to-EBITDA, trading at 12.2 times compared with 5.5 for Macy's, which brings to the fore Penney's debt-heavy capital structure. The company sports a debt-to-equity ratio of 3.42 compared with 2.01 for Macy's.
However, the company reported that increased liquidity allowed it to pay down $500 million in debt. Meanwhile, Penney is considering the sale and lease-back of its headquarters building in Plano, TX, which would allow further debt paydown.
The Customer View
We found it worth noting Penney's realistic view of itself in the American retailing universe.
CFO Record said on the conference call that the company's customer base has rebounded to its 2011 level and isn't going to grow much further.
"Half of American households shop with us. So the other half are either, we're out of their price range or we're not in their consideration set because they're on the upper end. So there's not a tremendous number of households that we're going to get to shop us. It's really we have that Middle America shopping us. We just need to get either more trips or more units per trip or more dollars per trip out of them."
To that end, Penney says it knows that online shopping, particularly from mobile devices will be key, as will BOPUS (buy online/pick up in stores).
On the merchandising front, Penney is reintroducing appliances to its stores after surveying its shoppers.
Risks
Penney may be overestimating the pocketbook strength of its middle-income constituency.
The Federal Reserve could miscalculate and continue to tighten as the economy weakens, curtailing spending and inaugurating a bear market.
The retail sector is brutally competitive. In addition to traditional brick-and-mortar rivals, Amazon and the rest of the online world multiply the pressure.
In any event, we expect JCP to outperform the market in 2016. As confidence continues to grow that the company can meet its goals, shares will continue to appreciate. That's right, Johnny Rocco. More.
Disclosure: I am am long JCP.