UBS Global Research analysts Michael Binetti and Steven Strycula reiterate a Sell rating for J.C. Penney Company, Inc. (NYSE:JCP).

J.C. Penney JCP

J.C. Penney’s lessons from the past

Our Sell rating on J.C. Penney Company, Inc. (NYSE:JCP) is partly based on our concerns about the company’s ability to bolster its deeply negative traffic trends of 2012 and H113 without the current level of heavy markdowns that it seems to need in order to recapture the attention of its wayward customers. A key part of J.C. Penney’s strategy to drive traffic back to its stores is the very strategy that we believe led to several years of negative same-store sales (SSS) trends prior to the radical turnaround attempt in 2012—over-exposure to private brands.

Short-term solution with easy same-store sales comps

Like Kohl’s Corporation (NYSE:KSS), prior to the 2012 turnaround attempt, J.C. Penney Company, Inc. (NYSE:JCP) had >50% of its sales coming from private label brands. Today, J.C. Penney is trying to put the legacy brands (St. John’s Bay) back into its stores. We believe refilling stores with private label brands will be a shortterm solution. J.C. Penney needs to demonstrate not only sustained SSS growth, but more importantly, a significant improvement in its GM to convince investors that it can compete for traffic with retailers like TJMaxx (which get equal “value” scores from consumers, but with access to brands that they prefer to J.C. Penney’s merchandise) without giving its products away.

J.C. Penney could struggle for market share

Investors with “upside scenarios” for J.C. Penney Company, Inc. (NYSE:JCP) that include sales growing in the mid/high single-digits on a consistent basis in 2014 and beyond are likely to be disappointed. The department store category is a structural share loser—with industry sales down 2% on average per year over the past 10 years. We believe J.C. Penney will struggle to gain enough share within a declining category as it shifts its merchandise back to the same private label brand strategy that resulted in several years of share losses in the past.

Valuation

We base our US$7.00 price target on 0.5x 2014E EV/sales.