Sterne Agee analyst, Chuck Grom, updates estimates for J.C. Penney Company, Inc. (NYSE:JCP) and says the next 6 months are the most critical in the company’s history. Details from his report below.
J.C. Penney Company, Inc. (NYSE:JCP) Our Call
The next six months are probably the most critical in J.C. Penney Company, Inc. (NYSE:JCP)‘s history. If comps can rebound to levels guided by management (3-5% in 1Q; MSD for year), liquidity issues/vendor concerns, etc. likely are avoided (albeit temporarily). Conversely, if SSS stay soft and inventory levels build (+25% YOY @ YE), J.C. Penney Company, Inc. (NYSE:JCP) will be in a precarious position heading into the back half. We’ll continue to monitor in-store trends for signs that’ll point us in either direction… until then, we’ll stay uninvolved.
J.C. Penney Company, Inc. (NYSE:JCP) 4Q Quality = “OK” … but SG&A Reaching Unsustainably Low Levels:
Adjusted for various one-time items, JCP reported PF 4Q EPS of ($0.76) vs. our ($1.05) and consensus of ($0.81). GAAP EPS was $0.11, but we exclude several items, including: (1) $0.16 in restructuring charges, (2) a $0.15 asset sale gain, and (3) an $0.88 tax benefit. Accordingly, compared to our model, the +$0.29 variance came almost entirely in SG&A as it contributed $0.56 in upside and D&A added a penny, with this upside partly offset by $0.24 lower gross profit margins, a $0.02 drag from a higher tax rate (on an operating loss, ~2% vs. company’s 0%), and $0.03 in previously not modeled Other/Real Estate Expenses. As expected, pre-announced SSS were up 2.0%, leading to an in-line revenue number. On the margin specifics, gross margin increased 461 bps to 28.4%, 200 bps below our 30.4% estimate, although we note a 190 bps negative impact from discontinued brands. Further, core SG&A expenses, on the other hand, came in well below our model at $1.004B (SA @ $1.185B), down a staggering 17%, leading us to question the sustainability of cost cuts, particularly given go-forward MSD sales growth targets. Overall, gross margin was fairly in line when considering the discontinued brands, so the bulk of the upside was SG&A driven, with expenses reaching extremely low, perhaps unsustainable levels.
• 6 Key Takes From Conference Call from J.C. Penney Company, Inc. (NYSE:JCP):
(1) Conversion, average transaction size, and unit per transaction were all “up” during 4Q13; (2) Store traffic was ~900 bps better than industry mall traffic, which was down about 15%; (3) Despite a tough month across retail, January delivered the best two-year sales stack for FY13; (4) Brands discontinued include: JCP Men’s, Stafford Prep, Joseph By Joseph Abboud, William Rast, Joe Fresh Kids, and JCP Everyday, with no further margin impact from these brands anticipated for FY14; (5) Re-merchandising of Home, Women’s apparel, and Intimates is set to take place in 2014. The new look for Home will include a refocus on bedding, bath, small electrics, and decorative accessories. Additionally, new brands will be launched in Home as well as Men’s and Women’s apparel this spring; (6) JCP expects to end FY14 with ~$2.0B in liquidity at year-end and trough liquidity (a.k.a. 3Q) of $1.0B.
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Importantly, this J.C. Penney Company, Inc. (NYSE:JCP) assumption does NOT include any further assets sales or capital infusion; however, the company noted that it’s been in talks with various banks to tap the ABL/term loan (~$500M available), if needed.
• Guidance Features Big Improvement in SSS & GPM in FY14. As we had expected, JCP outlined a 2014 forecast that was more optimistic than our model. Specifically, walking down the P&L, JCP sees SSS rising 3-5% in 1Q and up “MSD” in FY14 (management deferred commenting on February trends, which we interpreted negatively; nor did the team speak to the traffic/ticket complexion of its outlook). GPM is expected to “improve” vs. LY (sounds like still some leftover clearance will occur this quarter, likely in home) and be up “significantly” year over year for FY14. SG&A Expenses are expected to be “slightly below” last year in 1Q and not be “materially different” at the end of FY14 (note that SG&A $ dropped 17% in 4Q YOY). Favorably, as a result of strong market conditions in FY13, Pension Expense will flip to income of $5M in 1Q14/$19M in FY14. Finally, for the full year, D&A was set at $630 million, Cap-Ex at $250 million (down from $300 million previously), and a Tax Rate of 0%.
• Our New Estimates Post the Quarter & New Guidance. Based on the 4Q print/new guidance, we are now modeling EPS in FY14 and FY15 of ($3.24) and ($2.59), respectively, up from ($3.72) and ($3.12). When analyzing the near $0.50 change in our FY14 assumptions, we note that most of the increase came from J.C. Penney Company, Inc. (NYSE:JCP)’s better expense control in the quarter (~$0.49) and pension swing ($0.39), both of which were partially offset by lower GPM $ ($0.28) and lower sales ($0.10).Importantly, the key delta between our model and guidance is JCP’s more optimistic outlook for SSS. To this end, we are modeling comps of 2.0% in 1Q14 and 2.8% for FY14, below guidance.
J.C. Penney Company, Inc. (NYSE:JCP) Cash Flow & Balance Sheet Review:
J.C. Penney Company, Inc. (NYSE:JCP) generated roughly ~$246 million in cash (CFO less Cap-Ex) with the typical 4Q working capital infusion contributing $436 million, leading to a year-end cash balance of $1.515B and total liquidity of $2.024B (~$509M in revolver availability). Importantly, the company expressed expectations for trough FY14 liquidity levels (likely by 3Q end) of over $1 billion and year-end liquidity of over $2 billion, implying FY14 would be FCF neutral by year-end, with working capital a source of funds, presumably offsetting additional losses. Our assumptions are less optimistic as we expect 3Q14-end cash at ~$250M/liquidity of $760M and year-end cash of ~$975 million/liquidity of $1.480B. While we also see working capital as a source, our operating assumptions are likely less optimistic, as we see flat year-end inventories and FY14 comps at 2.8% vs. the company’s “mid single-digit” guidance. The good news is, as we wrote in our 2/19/14 report entitled