Goldman Sachs Group Inc (NYSE:GS) analysts believe J.C. Penney Company, Inc. (NYSE:JCP)’s greater emphasis on private labels should help the retailer capture its traditional customer base and drive its gross margin back towards historical levels.

J.C. Penney JCP

Stephan Grambling and Christopher Prykull of Goldman Sachs Group Inc (NYSE:GS) in their recent coverage on the retailer, however believe incremental markdowns are likely in the near term due to the re-merchandising.

J.C. Penney’s thrust towards private label

As Goldman Sachs analysts noted last week, J.C. Penney Company, Inc. (NYSE:JCP) announced it is continuing to reduce portions of its national branded inventory to emphasize more of its private label merchandise. The retailer plans to reduce the size of its Joe Fresh assortment and move the shop from its prominent location in the store, by replacing it with A.N.A. and JCP brand women’s wear.

The Plano, Texas-based retailer is also eliminating its J.C. Penney Company, Inc. (NYSE:JCP) men’s wear, reducing Michael Graves inventory and plans to introduce a line of Liz Claiborne home goods to replace the Martha Stewart-designed products.

As reported earlier, analysts from BMO Capital Markets commented on J.C. Penney’s strength among its private brands such as Modern Bride, St. John’s Bay and a range of national brands.

Target price reduced to $9.50

Goldman Sachs’ analysts have moved their estimates on J.C. Penney Company, Inc. (NYSE:JCP) lower due to less gross margin improvement. As the analysts take down their near-term gross margin estimates on the retailer’s merchandise reshuffling efforts and a promotional holiday period, Goldman Sachs Group Inc (NYSE:GS) analysts’ move their FY13/FY14/FY15/FY16 EPS estimates to ($5.64)/($2.20)/(1.22)/($0.33) from ($5.23)/($1.72)/($0.72)/ $0.12.

The following table depicts the analysts’ lower estimates:

JCP's lower estimates

Stephan Grambling and Christopher Prykull of Goldman Sachs Group Inc (NYSE:GS) moved J.C. Penney Company, Inc. (NYSE:JCP)’s 12-month price target from $11 to $9.50 based on an equal-weighted combination of DCF and EV/EBITDA scenario analysis.

As can be seen from the following table, price target is pegged at $9.50 based on the equal-weighted combination:

Equal weighted price target of JCP

The following table elucidates Goldman Sachs Group Inc (NYSE:GS) analysts’ DCF methodology to arrive at $10 per share:

DCF Valuation for JCP

J.C. Penney Company, Inc. (NYSE:JCP) has been in troubled waters for quite some time, given its waning revenues and increased losses. However, the company has taken several strategic initiatives to drive traffic and conversion. The company reverted to promotions, which could be a successful sales driver this holiday season. The retailer posted robust November comparable-store sales results followed by the upbeat sales results for the month of October.

Stephan Grambling and Christopher Prykull of Goldman Sachs, however, perceive the retailer could have to confront risks from macro induced SSS upside/downside, faster/slower recovery of comps and margins from initiatives, and greater-/lesser-than-anticipated cost control.