Charles Grom, CFA of Sterne Agee is initiating J.C. Penney Company, Inc. (NYSE:JCP) with a buy. Recently, JPMorgan also issued a positive report on Bill Ackman’s ‘baby‘. Below is a summary of the key points on why Grom is now bullish on the ‘troubled’ retailer.
Within the context of both our Barbell Strategy (balancing strong fundamental stories and mean reversion candidates) and Bull vs. Bear Study (see proprietary work herein), we are initiating coverage on J.C. Penney Company, Inc. (NYSE:JCP) with a Buy Rating and establishing a $23 Price Target. With the bear case very well advertised and a stock that’s on its back, particularly relative to the XRT, we’ll take the other side.
Points For J.C. Penney
Point #1: Investors Love a Clean Slate . . . Laterals to BBY/Old J.C. Penney. With bankruptcy off the table and new CEO Mike Ullman calling the shots, we think the table is set for a two-step trade in J.C. Penney Company, Inc. (NYSE:JCP). The first will come as the J.C. Penney team tells a new story, focusing on “where it’s going” not “where’s it’s been,” washing the slate clean. The second will come as J.C. Penney pulls out its old playbook – i.e., promotions, coupons, focus on private brands – while leveraging some of the instore/ product improvements/enhancements made by the former team.
Point #2: While 2Q Could Be Ugly . . . 2H Inflection On Tap. 2Q is a transition quarter for J.C. Penney Company, Inc. (NYSE:JCP) on the merchandising/messaging front. Said differently, adjustments to both promotions/advertising will take time to develop and it’s likely that Mr. Ullman will look to rebase inventory levels with more private brands/less contemporary product, leading to SSS that could stay subdued and GPM pressure. Looking out into 2H13, however, the combination of an aggressive ad campaign, revised promotional intensity, and leveraging its BTS brand strength (i.e., Arizona/Levi’s) should represent a SSS inflection.
Point #3: We See EBITDA of $1.6B and EPS of $2.00 by 2017. We’ve made three assumptions in our model. First, we believe J.C. Penney Company, Inc. (NYSE:JCP) has a big opportunity to recover some of the lost sales productivity it incurred in ’11/’12. Recall J.C. Penney’s SPSF hit an all-time low of $116 in ’12, relative to $195 in ’06. By ’17, we see J.C. Penney recouping some of this, conservatively hitting $143. Second, we’re modeling GPM improvement to 39.0% by 2017, a level that J.C. Penney achieved in 2006/2009 and recently confirmed by CEO Ullman as an interim target (1Q-3Q average of 38.7%). Third, we’ve assumed that J.C. Penney can operate on the leaner cost structure that former CEO Ron Johnson installed. Said differently, we’re keeping the company’s $39-$40 SG&A expense per square foot intact through 2017. The end result of is $1.6B of EBITDA/$2.00 in EPS by ’17.
Point #4: Reminiscent of M in ’08 & BJ in ’07. The J.C. Penney Company, Inc. (NYSE:JCP) Buy call is not for the faint of heart; frankly, it reminds us of prior calls on Macy’s (’08) and BJ’s (’07). The common thread between the three situations is/was: (1) a change in leadership/management structure; (2) noticeable changes in store that brought each retailer back to its core roots; and (3) a willingness to go against the herd.