Citi Research published a report today, April 8th, focused on the ongoing turnaround at J.C. Penney Company, Inc. (NYSE:JCP). Analysts Oliver Chen, Maryana Pleskanka and Nancy Hilliker crunch the numbers and make a convincing argument that the once-beleaguered retailer is well on its way to righting the ship.

The Citi analysts currently rate J.C. Penney Company, Inc. (NYSE:JCP) a Buy, and have placed an $11 price target on the stock.

J.C. Penney Price performance

J.C. Penney: Back to the basics

The Citi report concludes that J.C. Penney Company, Inc. (NYSE:JCP) has become a “going concern.” The analysts flesh out their bull thesis below: “In our view, what’s going to drive comp & healthier margins: (1) home department which is ~12% of mix and had severe space/product disruptions in 1H13; a revamped Home Collections at J.C. Penney has better price/value, renewed focus on bedding/bath/small electrics & decorative accessories; (2) fixing kids (~12% of mix), which was disrupted in 2H13 given space allocation to ideas which did not resonate; and (3) bringing percentage of clearance & merch. margin in-line with historic levels.”

J.C. Penney Margin Sensitivity

Better merchandise means less clearance markdowns

The crux of Chen, Pleskana and Hilliker’s bull thesis is better merchandise selection from J.C. Penney Company, Inc. (NYSE:JCP). They anticipate much less merchandise having to be marked down for clearance in 2014, which will in turn drive a significant increase in earnings.

The analysts quantify how less clearance merchandise could have a positive impact on the bottom line. “We believe 2014 could experience a lower 15% of clearance mix at a -5% merchandise margin, this difference would drive +570bps of upside in 2014 vs. 2013. The sensitivity is about +/- 15bps per +/- 1% difference in markdown levels or ~+/- 75bps for each +/-5%.”

The report also sketches out a base case and a bull case detailing the potential upside of reducing clearance merchandise. “An illustrative base case is 15% of clearance at -5% margin vs. 2013’s 20% of clearance at -20% margin (or +570bps of upside) and a bull case, back-to-classic JCP, would be 15% clearance at a +8% merchandise margin (or +765bps of upside vs. 2013).”

J.C. Penney Company, Inc. (NYSE:JCP) is trading down two cents at $8.86 as of 12:09 PM EDT today.