J.C. Penney: Reasons to Buy

J.C. Penney (JCP) had started the year on a positive note but lost its bearings of late. In the past two and half months its shares have declined approximately 28% after gaining 26% in the first-nine months of the year. However, this drop in my opinion creates an opportunity for value investors as the company is recovering its market share faster than expected, a trend expected to continue due to its turnaround initiatives. These initiatives have helped the company achieve excellent results for the third-quarter 2015. Let’s have a look.

Good growth

J.C. Penney’s results for the quarter were excellent with year-on-year growth at both top as well as bottom line.
In fact, its results topped the consensus estimates by a wide margin. The company reported sales of $2.9 billion, up 5% from $2.7 billion reported for the same quarter last year. Also, its losses came in at $0.47 per share as against $0.77 per share in the third-quarter of 2014. Thus J.C. Penney also beat the consensus forecast of -$0.55 per share on revenue of $2.88 for the quarter.

J.C. Penney is consistently attaining positive comp sales growth. For instance, for the third-quarter it reported 6.4% growth in the comp sales. This positive comparable store sales growth can be attributed to its efforts of accelerating dot-com growth through an enhanced platform and omnichannel functionality.

Improved clearance and promotional selling coupled with enhanced private brand penetrations as well as supply chain improvements also contributed significantly to this improvement in gross margins. The gross margin improved 70 basis points to 37.3% as compared to the same quarter last year.

Looking ahead, the company sees significant opportunities for continued margin expansion. It is executing variety of plans in order to improve its margins. It has recently leveraged private brand infrastructure that should possibly increase the rate of private brand penetration. The company expects gross margin expansion for the national brands that should help the company to close the year on a high note and deliver significant returns to its investors.

In addition, the company should benefit from the recently installed modern merchandising systems. These modern merchandising systems and item planning features help buyers effortlessly have a view at the assortments. At the same time it is enabling the retailer improve the in-stock and markdowns, while driving its utilization rate. This should additionally enhance its margins in the upcoming quarters.

Reduction in expenses and net debt are other positives

J.C. Penney has seen some improvement in its fundamentals during last reported quarter. It saw its SG&A expenses falling to 32.7% of sales as compared to 35.7% last year. This 300 basis point improvement is driven by reduction in store controllable expenses, more efficient advertising and increased revenue from its private label credit card. As a result, for the first-nine months, J.C. Penney reduced its SG&A expenses by $148 million or 280 basis points. This should help the company improve its bottom line performance this year.

These operational improvements coupled with sales growth are allowing the company to generate significant free cash flows that it can use to pay off its debt. In fact, the company has already reduced its long-term debt by $80 million this year so far. This is positive news for its investors as this reduction in the net debt will lead to further reduction in its annual interest expenses for the year.

J.C. Penney has $5.3 billion in debt and interest costs that are equal to 64% of its guidance for Adjusted EBITDA in 2015. But it had only $638 million cash at the end of the third quarter. The table illustrates its continuous efforts of reducing its long-term debt.

Conclusion

J.C. Penney is benefiting tremendously from its turnaround initiatives that should help the company continue generating positive free cash flows this year and possibly deliver positive earnings by next year. Its sales have started picking traction and margins are consistently expanding. Also, it is investing in the growth opportunities that further ensure its growth platforms in the future.

But its debt load is quite high and more vulnerable than most department stores to a broad slowdown in retail sales. It is still only expecting to deliver breakeven cash flow in 2015. However, it’s only the high end retailers like Nordstrom and Macy's facing problems and that too due to a slowdown in international tourist spend. For the mid-market players like J.C. Penney, it’s a great opportunity to gain market share. Hence, investors should like J.C. Penney at the current prices unless they believe that a major slowdown is imminent.
Published on Feb 5, 2016
By Yaggyaseni Mittra

Copyrighted 2016. Content published with author's permission.

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