Is JC Penney Really Out Of The Woods?

Shares of JC Penney (JCP) are rising 9% this morning, to $9.50 each, after the department store chain reported that it lost a whopping $489 million during the third quarter. That loss equates to $1.94 per share, or about 20% of the entire share price. The actual amount of cash the company burned through (excluding the impact of non-cash accounting items) was even worse, coming in at $737 million. And yet the stock is very strong today and Bob Pisani of CNBC reported earlier that traders on the floor of the stock exchange were upbeat because it was clear that JC Penney was going to survive.

I found that conclusion to be quite interesting. I suspect they haven’t actually looked closely at the numbers. Claiming that JCP is out of the woods after losing more than $700 million in a single quarter strikes me as odd, even though the company’s sales have begun to stabilize (up less than 1% in October after a couple years of declines). I am not predicting JCP files for bankruptcy, but I will point out that the odds that it will are most certainly more than zero. Not only that, even if they do make it and return to profitability in the next couple of years (2014 is a stretch, but it could happen in 2015 if things go right), the stock today at $9.50 does not appear to be much of a bargain at all.

Take a look below at a three-year financial projection spreadsheet that I put together today. You will see that I assume that JCP can grow sales by 10%, 8%, and 5%, respectively over the next three years. Furthermore, I assume that the company’s gross margin can improve by 2-3% per year, and SG&A costs rise more slowly than sales. The end result is not very positive for equity investors, despite today’s strong market performance for the stock.



As you can see, JCP reaches EBITDA-breakeven in 2014 and by 2016 generates $1 billion of positive operating cash flow. The problem is that capital expenditures and interest on the debt they have raised over the last two years eats up most of that cash. The end result is very little value left for equity holders. By my calculations, if the stock is valued at 6x EBITDA like other department stores (Macy’s, Kohl’s, Dillards, etc), it would only fetch about $6 by 2016, about 33% below the current quote. And that assumes sales grow from $12 billion this year to $15 billion over the next three years (certainly possible, but far from assured) and margins expand by a similar percentage as well.

Color me skeptical as to why investors are lining up today to buy JCP at nearly $10 per share today.

Full Disclosure: Long JCP senior bonds at the time of writing, but positions may change at any time