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JCP: Duration Matters More Than Ever

Takeaway: Duration matters as much today on $JCP as it did when evaluating it as a short at $40. TRADE = look elsewhere. TREND/TAIL = do the work.

This note was originally published March 05, 2013 at 22:08 in Retail

Conclusion: Pick your duration. It matters -- as much today as it did when evaluating it as a short at $40. If you need to make money in a name before June, don’t look to JCP. The first quarter will be weak, 25% of square footage is unshoppable during the quarter due to construction, and EPS expectations might not be low enough. But if you can you can look to a TREND (2H) or TAIL (3 Yr) duration, we think the risk/reward favors the upside.  Here’s an overview of the incremental changes in our thought process on JCP over the past week.

 

Full Details

We were short JCP since Ackman first brought in Johnson starting in June 2011. The crux of that call was that there was a duration mismatch between the time period Johnson was incentivized to fix JCP compared to how quickly Wall Street was being led to believe (by management and Ackman alike) that a turn would take place.

 

That call worked quite well, but we turned positive earlier this year at $19, however, as we thought that the risk/reward was to the upside and that all the bad news was priced into the stock. That was clearly a wrong assumption. We go through the puts and takes below, but with the downward spiral since the quarter we’re left with the question as to whether we should fish or cut bait.

 

We’re not going to sell into the emotion-fueled debate we see out there today. Instead, we think that the real answer to the buy/sell question is different based on each of our three durations, TRADE (3 weeks or less), TREND (3 months or more), and TAIL (3-years or less).

 

1. TRADE: While we won’t bow to the negativity that’s currently swirling around this ticker, the fact of the matter is that there’s nothing we can point to before June that will make this stock go up. There’s a) the Martha Stewart/Macy’s trial (which could go either way), b) nearly 25% of JCP’s square footage that will be under construction (and therefore unshoppable), and c) the start of JCP’s cash burn into spring while catching up on vendor payables. Package all of this with zero guidance from management on the quarter, and the Street looking for a relatively rosy -7.8% comp in the quarter (a 500bp acceleration on a 2-year basis), and the setup into the May 1Q earnings report is nothing to write home about.

 

2. TREND: Once we’re past 3-months, we think that that the ‘rate of change call’ as it relates to JCP’s top line will start to unfold. Maybe that did not matter as much when the stock traded through $23 in advance of the quarter, but we think it matters at $15. Even if JCP needs to buy the comp, we think that sales trajectory will be the sole factor over a TREND duration that people will care about in answering the question as to whether it actually has connectivity to its consumer or not.  As goes customer connectivity, so goes the stock.

 

For the year, our key modeling assumptions vs consensus are outlined in the table below. Assuming that JCP still runs at a whopping ($2.12) loss per share, we have the company using up $1.1bn of its revolver in order to maintain a cash balance of about $450mm. This assumes a very conservative -$500mm hit to working capital after cutting into too much bone last year, and also assumes no cuts to the company’s $1bn capex plan.

 

JCP: Duration Matters More Than Ever - 111a 

 

3. TAIL: While our TAIL duration is 3-years or less, we’re going to cheat a little bit and take this model out a full 5-years. We think we can get to earnings power starting with a $3 over that time period assuming that JCP only flirts with its former glory when it was simply a ‘bad’ instead of a ‘horrific’ retailer.  Let’s be clear about one thing…we’re not parroting the Ackman earnings power of $14-$22 per share (yes, he actually said that).  But our point is that we don’t need that kind of earnings power for the stock to work over a TAIL duration.

 

JCP: Duration Matters More Than Ever - 222jcp

 

Our Updated Thoughts On Key Issues Impacting The Stock

Here’s an overview of what has changed since the print, where we think were wrong, where we’ve been challenged by investors, as well as our response.

  1. Expectation Mismatch: in reflecting further in the quarter, you don't have to be a genius to see that we got the near term research call wrong. Ironically, for the quarter, we modeled a -35% comp, 24.5% gross margin, and a loss of -$2.50 per share, which is pretty darn close to where JCP came in. Trade receivables were worse than we expected, but net cash on hand was still greater than the $550-$650mm we said we needed to see to prevent liquidity concerns. Our mistake was assuming that these below-consensus estimates were ‘in the stock’. Lesson learned = a large scale negative headline is rarely ‘in the stock’.
     
  2. VNO Stock Sale: The second largest shareholder selling a 10mm share block on the day Ron Johnson was on trial being grilled by Macy’s lawyers about the dispute surrounding Martha Stewart product was tough to see coming. That said the stock traded down over 5% in the session leading up to the announcement – so someone not only saw it, but unethically profited from it. 
     
  3. Timing of Shop Rollouts: If the Martha Stewart trial goes against JCP, we have a very hard time believing the news headlines saying that ‘shelves will be empty’. Rather, we think it’s more likely than not that the product branding or design will need to change in a way to make it clearly not conflict with Macy’s. We don’t think that it will delay the shop opening by more than a month or so, but we think that it could delay the Martha Stewart productivity ramp by 1-2 quarters.
     
  4. Consumer Sentiment: This whole debacle has gotten so much negative press. Check out $JCP on twitter. No exaggeration that 99% of mentions are negative. The company, the management and the brand seemingly has no support – at least by this audience (we trust twitter more than Wall Street sentiment factors in this regard).  Usually such negative sentiment supports a bull case, but the bear case would be that such negativity actually manifests itself in the form of backlash against shopping at the store. In other words, after firing the existing customer and being consistently in the hot seat in front of the American Consumer at large, could it actually prevent the new shop rollout plans from working?  It’s a question that we need to be asking ourselves.
     
  5. How Many Shops Should There Be? We debated this one with several clients, and we think that it’s a very valid question. JCP is reconfiguring 700 of its 1,100 stores. But the question is how JCP arrived at that 700 number. Why not 500? 300? It can do all the studies it wants, but the reality is that it won’t know the appropriate number of stores for this new format until it goes too far. The solace we have from a modeling perspective is that we’ll assume that management has the common sense to start at the very top as it relates to attractiveness and potential likelihood for success. It’s going after 500 over the immediate-term, so it clearly has room to stall or alter capex plans if the data suggests that their 700 estimate is too high.  
     
  6. RJ’s Job Security: Better than 50% of investors we talk to think that Ron Johnson won’t be working at JC Penney in 2014.  We disagree. Simply put, JCP was a horrible retailer before he joined. Then the Board gave him a mandate to change the model. They expected disruption in sales. Did they expect first year sales to be down 25%? Probably not. Did Johnson make some serious errors? Absolutely. But the Board is getting what it asked for – a radical transformation in the business model.

    What are they going to do…fire Johnson and bring in another person to return the company to its former glory? No way. In fact, we think that vendors still hold Johnson in high regard and buy into his vision as to what JCP should become. If he personally ceased to exist in his role as CEO, there’s serious risk to vendors pulling out of JCP en masse to protect their own brands.  
     
  7. Real Estate Value Support: When Ackman did initial storytelling about JCP, he talked up a replacement value of $11bn, or about $50 per share. That’s fine, but there’s a pretty big flaw in that analysis – we’d argue that if JC Penney stores are so grossly underperforming, there’s no need for them to be replaced. Hence we could argue a theoretical replacement value of zero. We can, however, argue something closer to $8-$10 per share. Our assumptions are as follows.

A ) Cap Rates: While cap rates have been drifting lower, JCP would still command among the highest cap  rates due to its sub-prime real estate locations. Let’s assume 8.5% vs Power Center/Strip/Regional Mall average of 7.0%.

B) Rent: Current JCP rental rate is about $4 per square foot on its leased property. It’d be tough to argue something higher than that today. Let’s assume something between $3.50 and $4.00.

C) Combining the two, we’re getting to a value of $8-$10.

 

The key here is not that the portfolio will be liquidated overnight. But rather that it has about $1.8bn-$2bn of near-term liquidity it can access if need be.

 

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Bigger and Stronger America

Client Talking Points

Growth Accelerating?

Back in 2012, we went from #GrowthSlowing to #GrowthStabilizing. Now that America has had some time to digest the move and we're getting awesome labor market and housing reports week-after-week, perhaps we are ready to move to #GrowthAccelerating? Consider this data:

 

  1. ISM Manufacturing New Orders accelerated from 53.3 in JAN to 57.8 in FEB
  2. ISM Services New Orders accelerated from 54.4 in JAN to 58.2 in FEB
  3. PMI Manufacturing New Orders accelerated from 58.2 in JAN to 60.2 in FEB

"Not too shabby," some would say. Well if you combine that with falling oil prices and a stronger dollar, you get growth and an uptick in consumption. That helps drives stocks as consumers flock out to the grocery store, unafraid of what the price of milk may be this week. Things are getting good and they are willing to get better. When that happens, everybody (except the bears!) wins.

 

Asset Allocation

CASH 24% US EQUITIES 24%
INTL EQUITIES 24% COMMODITIES 4%
FIXED INCOME 0% INTL CURRENCIES 24%

Top Long Ideas

Company Ticker Sector Duration
ASCA

We believe ASCA will receive a higher bid from another gaming competitor. Our valuation puts ASCA’s worth closer to $40..

FDX

With FedEx Express margins at a 30+ year low and 4-7 percentage points behind competitors, the opportunity for effective cost reductions appears significant. FedEx Ground is using its structural advantages to take market share from UPS. FDX competes in a highly consolidated industry with rational pricing. Both the Ground and Express divisions could be separately worth more than FDX’s current market value, in our view.

HOLX

HOLX remains one of our favorite longer-term fundamental growth companies given growing penetration of its 3D Tomo platform and high leverage to the 2014 Insurance Expansion from the Affordable Care Act.

Three for the Road

TWEET OF THE DAY

"I know, why use credible #WallSt2.0 sources when you can bang your head against the Old Wall #GDP" -@KeithMcCullough

QUOTE OF THE DAY

"In a mad world only the mad are sane." -Akira Kurosawa

STAT OF THE DAY

Private sector adds 198,000 jobs in February according to latest ADP report.


What Keith's Reading

Service Industries in U.S. Grow at Fastest Pace in a Year (via Bloomberg)

 

Australia Expands at Fastest Pace Since 2007 on Exports: Economy (via Bloomberg)

 

Kuroda to Hit ‘Wall of Reality’ at BOJ, Ex-Board Member Says (via Bloomberg)

 

Asian Stocks Climb on U.S. Data, Global Stimulus Bets (via Bloomberg)


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP – March 6, 2013


As we look at today's setup for the S&P 500, the range is 24 points or 1.35% downside to 1519 and 0.21% upside to 1543.      

                                                                                                                         

SECTOR AND GLOBAL PERFORMANCE


THE HEDGEYE DAILY OUTLOOK - 1

 

THE HEDGEYE DAILY OUTLOOK - 2

 

THE HEDGEYE DAILY OUTLOOK - 3

 

THE HEDGEYE DAILY OUTLOOK - 4

 

EQUITY SENTIMENT:


THE HEDGEYE DAILY OUTLOOK - 10


CREDIT/ECONOMIC MARKET LOOK:

  • YIELD CURVE: 1.68 from 1.66
  • VIX  closed at 13.48 1 day percent change of -3.78%

MACRO DATA POINTS (Bloomberg Estimates):

  • 7am: MBA Mortgage Applications, March 1 (prior -3.8%)
  • 8:15am: ADP Employment Change, Feb., est. 170k (prior 192k)
  • 8:15am: Fed’s Plosser speaks on economy in Lancaster, Penn.
  • 10am: Factory Orders, Jan., est. -2.2% (prior 1.8%)
  • 10:30am: DoE Energy Inventories
  • 11am: Fed to purchase $1.25b-$1.75b notes in 2036-2043 sector
  • 2pm: Federal Reserve releases Beige Book
  • 8:30pm: Fed’s Fisher speaks in San Antonio, Texas

GOVERNMENT:

    • 9:30am: Attorney General Eric Holder testifies at Sen. Judiciary Cmte oversight hearing
    • 10am: House Appropriations oversight hearing on Sandy disaster relief, recovery
    • 0am: House Fin Svcs panel meets on Fannie Mae, Freddie Mac role in financial crisis
    • 2pm: Congressional Gun Violence Prevention Task Force hearing on using background checks to prevent criminals, mentally ill from getting gun

WHAT TO WATCH

  • Kuroda will have limited options for easing at BOJ, ex-board member says
  • Dow index futures higher after closing at record yday
  • Obama seeks budget deal by phoning Republicans in spending talks
  • HSBC sells U.S. consumer, homeowner loans for $3.2b
  • Hewlett-Packard faces mounting pressure to remove Chairman Lane
  • Martha Stewart says J.C. Penney designs ‘absolutely allowed’
  • Home Depot sued by PayOne over patent-infringement claims
  • Artisan Partners seeks to sell 11.5m shrs in 2nd run at IPO
  • Cantor’s Johnson said to join Alcentra for U.K. direct lending
  • Capital One CEO gets cash pay for first time since 1997
  • Drought conditions in U.S. seen improving after snow, USDA says
  • LinkedIn wins dismissal of consumer privacy suit over hacking
  • Hugo Chavez, Venezuela’s anti-U.S. socialist leader, dies at 58

EARNINGS:

    • Staples (SPLS) 6am, $0.45
    • Fresh Market (TFM) 6am, $0.44
    • Big Lots (BIG) 6am, $1.98
    • Vail Resorts (MTN) 7:15am, $1.69
    • Brown-Forman (BF/B) 8am, $0.70
    • American Eagle Outfitters (AEO) 8am, $0.56
    • Laurentian Bank (LB CN) 8:40am, C$1.29
    • Hovnanian Enterprises (HOV) 9:15am, $(0.10) - Preview
    • Veresen (VSN CN) 1:54pm, C$0.10
    • PetSmart (PETM) 4:02pm, $1.21
    • Semtech (SMTC) 4:30pm, $0.43
    • DryShips (DRYS) 5:00pm, $(0.14)
    • Colony Financial (CLNY) 5:45pm, $0.38

COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)

  • Brazil and Colombia Seen by ICO Making Up for Coffee Rust Losses
  • DuPont Faces Another Year of Pigment Price Declines: Commodities
  • Brent Trades Near Four-Day High on Pipeline Halt; Chavez Dies
  • Wheat Falls on Indications World New-Crop Supplies Set to Climb
  • Copper Falls on Concern Demand Is Weak Amid Ample Inventories
  • Gold for Immediate Delivery Falls to $1,574.34 an Ounce
  • Coffee Falls for a Second Day on Brazil, Colombia; Cocoa Drops
  • Iron Ore Trading Doubled to 18.35 Million Tons for February
  • Japan Said to Plan Talks With South Korea on Joint LNG Purchases
  • U.K. Gold Hallmarking at Lowest Since at Least ’07 on Price Gain
  • India Seen Boosting Wheat Exports From Stockpiles Before Harvest
  • China Joining U.S. Shale Renaissance With $40 Billion: Energy
  • Hedge Funds See Coffee Slump as Supplies Grow: Chart of the Day
  • Iron Ore Price Surge Partly Due to Manipulation, NDRC Says

THE HEDGEYE DAILY OUTLOOK - 5

 

CURRENCIES


THE HEDGEYE DAILY OUTLOOK - 6

 

EUROPEAN MARKETS

 

THE HEDGEYE DAILY OUTLOOK - 7

 

ASIAN MARKETS

 

THE HEDGEYE DAILY OUTLOOK - 8

 

MIDDLE EAST


THE HEDGEYE DAILY OUTLOOK - 9

 

 

The Hedgeye Macro Team

 

 

 

 

 



American Progress

“He gave the nation the idea of American progress.”

-John Meacham

 

That’s what John Meacham wrote about Thomas Jefferson in his prologue to the latest brick I tackled on a flight yesterday to San Francisco, California: Thomas Jefferson: The Art of Power.

 

To his friends, who were numerous and devoted, Jefferson was among the greatest men who ever lived… to his foes, who were numerous and prolific, Jefferson was an atheist and a fanatic, a demagogue and a dreamer.” (Prologue xxiii)

 

Do you have a vision for your family and firm? Are you a dreamer? I am. And I’m damn proud of it too. Listening to politicians who don’t get liberty, free markets, and the purchasing power of success (#StrongDollar) has run its course. It’s a cycle. And so is American Progress.

 

Back to the Global Macro Grind

 

At this point, the sequential progress in the US Economic data from December 2012 to March 2013 is glaringly obvious. When my signals tell me to, I have no problem fighting the Fed. But I don’t fight the data.

 

From US Housing to Employment (they progressed first), to more coincident economic indicators like yesterday’s ISM Services report (best since 2011), the risk management question now isn’t “where do I sell?” It’s “could growth stabilizing become #GrowthAccelerating?”

 

We analyze a lot of “stuff”, but some of the more forward looking “stuff” comes in the form of new order growth:

  1. ISM Manufacturing New Orders accelerated from 53.3 in JAN to 57.8 in FEB
  2. ISM Services New Orders accelerated from 54.4 in JAN to 58.2 in FEB
  3. PMI Manufacturing New Orders accelerated from 58.2 in JAN to 60.2 in FEB

So, if you use that “stuff” (otherwise known as economic data), you’d answer yes to the question of recent American Progress. But these are new orders, what about new consumption growth tailwinds that we didn’t have in JAN or FEB?

 

How about Oil prices coming down? Amidst all of the #PoliticalClass fear-mongering about the spending problem they created, could Sequestration = Strong Dollar = Down Oil = Stronger real (inflation adjusted) Consumption Growth?

 

I’m no atheist, and my loathers can call me fanatic about this Strong Dollar Tax Cut idea all they want, but history sides with the Canadian on this front, bros. As you can see in today’s Chart of The Day, under both Reagan (1) and Clinton (1), American Progress was built on the back of a Strong Dollar, pro growth, recovery.

 

How does Mr Market score our theme of being long Consumption?

  1. US Healthcare Stocks (very much an American Consumption story) = +11.33% YTD (XLV)
  2. US Consumer Staples Stocks = +10.72% YTD (XLP)
  3. US Consumer Discretionary Stocks = +9.66% YTD (XLY)

Yes. All of those are beating what’s been a fantastic +7.9% YTD return for the SP500. And how does Mr Market score being short (or underweight) Commodity Inflation Expectations?

  1. US Basic Materials Stocks = +3.41% YTD (XLB is the worst performing Sector in the S&P Sector Model)
  2. CRB Index (19 commodities) = -1.35% YTD (awful relative to any major asset class)
  3. WTI Crude Oil = -1.4% YTD (having recently broke our $93.79/barrel TREND line of support)

OK. So being long Consumption growth and short Commodity exposures is still working. How is the end of the world trade going?

  1. Gold = down again this morning to $1574, = down -6.02% YTD
  2. US Treasuries = 10yr Yield up to 1.92% this morning = up +9.09% YTD

Again, if the world was going to end: A) all US economic data wouldn’t have gone from slowing to stabilizing to accelerating (look at the slope of the line) and B) Gold and Treasuries wouldn’t be losing you money in 2013 YTD.

 

I know, I know. People want to bring up what happened last year, and the year before that. I know, it’s like arguing with my college girlfriend. It was painful. But I got over it.

 

I don’t live a regressive life. I’m writing about American Progress because we have a tremendous opportunity here. What’s not only been happening for 3 months, but what could keep happening if the #StrongDollar setup remains excites me. It should excite you too.

 

Look at your screens. Markets are testing all-time highs. Be a leader. Be proud. Cut government spending. Get these people you already have on mute off TV. Let’s get back to what makes this country the most progressive that the world has ever seen. This is our chance.

 

Our immediate-term Risk Ranges for Gold, Oil (WTIC), US Dollar, USD/YEN, UST 10yr Yield, VIX, Russell2000 and the SP500 are now $1, $89.76-91.98, $81.76-82.38, 91.79-94.68, 12.21-14.63, 910-932, and 1, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

American Progress - Chart of the Day

 

American Progress - Virtual Portfolio


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.33%
  • SHORT SIGNALS 78.51%
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