CONCLUSION: We continue to have a net positive bias on JCP, and think that shorting it is a very risky bet. That said, we cannot get fully on board while the current CEO is at the helm. The reality is that he is there to stabilize the business until a new CEO can step in. For now, there is zero long term strategy, and we’re left with a CEO that is good at selling below average product at a heavily discounted price to very average Americans. That’s not much to sink out teeth into. If we could say with 100% certainty that the company will NOT go with Ullman as permanent CEO, then perhaps we’d take a leap of faith. But we can’t, so we won’t. All-in, we’ll be fine getting involved a few bucks higher once our confidence grows. If this story really starts to play out, we could build to it being a 2-3-bagger from here, and won’t mind buying in the mid-high teens.
There’s no shortage of cross currents out there today on JCP, but there were a items that stuck out to us as being particularly noteworthy.
1) The fact that the company hit the liquidity levels it guided toward at quarter-end is notable. Add on the fact that capex next year is guided to be down as far as $300mm, and the liquidity picture looks less pressured. We’d argue that these two factors are the sole reasons why the stock was up today. Why?
Let’s stress test the model. We quarterized our model for the next three years using the following assumptions a) JCP reaches 2012 sales per square foot levels in 2015, with a gradual comp lift throughout, b) the company generates 37% gross margins – a level we think there is no structural reason it can’t hit again relatively quickly (we know we'll get pushback on that -- but will happily entertain the debate), EBIT margins don’t turn positive until 2016, c) capex increases by $50mm each year, d) working capital patterns are similar to what we saw before 2012.
Source: Hedgeye Estimates
In tracking the cumulative liquidity for the next three years, there are two periods where it definitely gets dicey for JCP (the worst is 3Q15 -- in two years) – close enough such that it will likely need to find some asset sales that are not already tied to the GS secured debt offering. But even without assuming a miraculous turn at the company, we don’t get to a big liquidity event.
2) One thing we can’t stress enough is that for this management team, a $300mm capex budget is music to our ears. We don’t want them spending money. You don’t need to spend capital to stabilize a business like this. That said, the most we could give JCP is $1.5-$2.0Bn in sales on an anemic capex budget. If we want to start to think big with the top line, we’re going to think bigger with a re-capitalization.
3) The fact that JCP’s sales sequentially improved throughout each month in the quarter cannot be overlooked. Yes, we know they still stunk something awful. But we can’t ignore the simple fact that JCP’s sales were better in the margin at the precise time that other retailers are feeling some pain. There is a higher level of competition for Consumers’ apparel dollar today than there was last year when JCP was writing a $4.3billion check to anyone else who wanted a piece.
4) Listening to Ullman talk on that conference call about the importance of Worthington, St. Johns Bay and Arizona was borderline painful. It confirms what we’ve always known to be true – that Ullman’s strength is in selling below average product at heavily discounted prices to Average Americans. That said, Average Americans ditched JCP over the past two years, and subsequently destabilized the company. Ullman is probably the right guy to do it.
5) Our worst nightmare would be if we’re sitting here in another 3-6 months and the Board comes to a realization that Ullman is the right long-term guy for the job. That’s simply the wrong call. We think being short JCP here is unwise. But if that press release ever hit the tape, we’d likely sell every share we could find.