JC Penney: The Bar is Just Too Darn High

JC Penney (JCP) has come a long way since the once-proud retailer traded at a 30-year low and analysts were predicting $2.50 a share.  Sterne Agee’s Charles Grom and team aren’t sure how much further it can go, now that JC Penney has gained 70% since its Feb. 4 low. The reason: JC Penney management has set the bar too high:

…after working the numbers in detail, we believe management has set the comps/margin bar arguably high and with execution risk elevated and P&L losses looming, visibility into fair value is minimal…

Simply put, running the math implied by “break-even FCF guidance” suggests JCP believes the business will improve markedly in coming quarters. To this point, we can back into a rough net income number. Starting with zero FCF, we adjust upward by: (a) adding back $250.0 million in cap-ex and (b) subtracting out $630.0 million of D&A, resulting in a net “loss” of $380.0 million. Taking this one step further up the income statement, assuming 2Q-4Q comps of ~5.0% (FY14 guidance is “mid single-digits”) and keeping our other modeled P&L assumptions intact means that 2Q-4Q GPM needs to be ~39.9% in order for JCP to lose $380 million. Of course, this is likely too aggressive as JCP expects working capital to be a source of funds (although not quantified by the management team), which means the implied net loss as well as the implied comps/GPM would be lower.

…barring an unforeseen cash benefit, a dramatic improvement in Penney’s underlying business over the next few quarters in embedded in company targets. Given, the execution risk (and despite our encouraging store checks), we prefer to take a more conservative stance for now.

Shares of JC Penney have gained 0.9% to $8.63 at 2:01 p.m., impressive considering that its competitors have mostly fallen today. Macy’s (M), for instance, has dropped 0.6% to $58.12, while Kohl’s (KSS) has declined 0.5% to $52.80 and Dillard’s (DDS) is off 0.7% at $115.69.