Great news out of JC Penney this evening, as the company reported a 10.1% comp in November. We admit that it's only a partial window into the quarter. But, this validates three core parts of our JCP thesis.
- There are so many things at JCP that are broken, but absolutely none of them are beyond repair. Consensus won't acknowledge the concept of JCP earning money, while we think that $1.50 in earnings power is within reach (that's up from our recent $1.30 estimate). Once people internalize this eventuality, we think we're looking at a $20 stock (low teens multiple, though we could argue higher).
- Even though Wall Streeters may not be big JC Penney shoppers, the fact of the matter is that the average American consumer genuinely wants JCP to exist. Tough for Wall Street to believe, but our work suggests that it's 100% true.
- JCP is absolutely gaining share -- when it comps 10% -- 3-5x its average competitor -- it's tough to argue otherwise.
*Our research is based in part on our survey work -- which suggested last month (before KSS missed and JCP beat 3Q) that JCP was regaining share, and that KSS was likely the biggest donor. We've updated our survey, and will be ready to share our insight (and incremental trends from our last survey) early next week. Please contact email@example.com if you are interested in the results.
BEARS ARE STILL GROWLING
We've gotten a lot of feedback from bears this evening -- including 1) 'they were up against an easy comp' and 2) 'we don't know inventory levels or gross margins.' The latter point is true. We don't know margins. But we have a rather strong sense that they were better than last year. We still think that a return to the mid-high 30s Gross Margin is likely -- from the depths of the 22% where Johnson forced them. We need to keep in mind that Gross Margin is one of the easiest lines to destroy on the P&L over a short period of time (i.e. Ron Jon eliminating $2.5bn of 48% GM private label). But unlike other industries, in retail it is also the one line where you can shake the etch-a-sketch clean and return to meaningfully higher levels over a 12-18 month time period.
As it relates to the bears' 'it's irrelevant -- it was an easy comp' argument, we think that's an absolutely ridiculous point. The reality is that last year JCP lost a tremendous amount of market share -- $4.3bn to be exact. And now it's taking it back. When they take it back from KSS -- who we estimate stole $800mm in sales -- is KSS going to say…'that's ok, we took a lot of share last year, so it's ok if our sales are down.' Yes, we know how ridiculous that sounds. But the reality is that JCP is growing 3-5x ahead of its competitors. And that can't be glossed over.
Here's A Chart That Shows Us Who Took The Most Share From JCP. As Noted, Our Updated Survey Hits Next Week and We Will Be Able To See Incremental Trends
HERE'S ONE OF THE MOST IMPORTANT CONSIDERATIONS AS IT RELATES TO OUR BULL CASE
First, as a precursor, we need to reiterate that we are in no way perma bulls on JCP (we're not 'perma' on anything). We were short this name at $42 when Ackman was parading around his $12 in earnings thesis. We turned positive earlier this year when we thought perception of fundamentals as well as sentiment had overshot on the downside.
As it relates to earnings power, let’s keep an important factor in mind…JCP is operating at $100 per square foot. That’s embarrassing. Kohl’s, which we think has structural issues and has been at the top of our short list – is running close to $210/sq ft. Before Johnson worked his magic, JCP peaked at $190 per foot.
Our point here is that we don’t have to assume that JCP becomes a great retailer. We don’t have to even believe that it will be an average retailer. It can remain in the lower quartile – a notch above Sears even – and operate at $140/square foot. And it can get there by simply fixing some of the factors that Johnson damaged during his triumphant reign.
Alongside $140/square ft., our other key assumption is that Gross Margins get back to 37%, which we think is very doable – despite the severe pushback we get on this assumption. Ron Johnson decimated JCP’s private label brands, which cost the company about $1bn in gross profit – that’s what happens when you remove $2.5bn in sales at a 48% gross margin and substitute that with $900mm at a 33% gross margin.
Here are some of our recent clips from HedgeyeTV. Comments are welcome, as always.
Here's Our Note After JCP Surprised on the Upside With 3Q Results Last Month
JCP: The Bear Case Just Shrunk
Takeaway: This is going to be the Q where people look back and say “yeah, that was the point where I should have realized JCP is a viable entity.”
The list of ‘what’s changed’ to our thesis on JCP in the wake of its print is a very short one. In fact, it’s nonexistent. Were there questions that emerged that we need to get answered? Of course there were. That’s what happens when a company loses $1.94 per share. But far more questions were answered than were raised. Here’s some of our thoughts.
- EPS of ($1.94) missed the Street’s ($1.70) but the reported number includes a $0.73 loss associated with a tax valuation allowance. We don’t think EPS was the most relevant statistic this quarter as share count estimates were all over the place given the mid-quarter equity offering. Nonetheless, on an adjusted basis, we’d say that they probably beat.
- By now everyone knows that JCP voluntarily repaid $200mm on its revolver. It’s worth reiterating as that’s not behavior one would expect from a company about to file Chapter 11.
- Guidance for 4Q includes; a) additional sequential improvement in top line and gross margin – and both positive vs last year, b) DOWN sg&a versus last year, and liquidity to be in excess of $2bn. We don’t think that down SG&A is sustainable for any extended period of time – nor do we want it to be. But for now, we’ll take it.
- That point on liquidity guidance is the most important. The big bears out there had estimates for year-end liquidity of $1.5bn to $1.8bn. Again, companies with stocks going to zero don’t take up liquidity expectations.
- One of the biggest factors we had to rectify is the fact that gross margins were weak at the same time the company brought back higher-margin private label. But what we did not consider is the fact that JCP is still dealing with merchandise that was ordered under Johnson’s regime – brands that the consumer simply does not want. This is product that is going out at a gross margin in the 15-20% range. That’s seriously offsetting the high-40% GM JCP realizes on private brands like Arizona, Worthington, and St. John’s Bay. We did extensive consumer survey work around these brands – and although most people reading this note might not want them, the average American definitely does.
In the end, this is going to be the quarter where people look back and say “yeah, that was the point where I realized JCP wasn’t going under”. We know that this isn’t a major bullish statement, but it certainly removes the most bearish case being throw around – and that’s the case that nearly every short is banking on (and yes, JCP remains one of the most heavily shorted stocks in the S&P). People are still going to have to buy in to the premise that this company can see an acceleration in sales/square foot to a level that can sustain a respectable earnings level. We think JCP pierces through $120/ft in 2015 – which will mark its break-even year. That might not sound too enticing – after all, we all like for companies to make money instead of simply not lose money. But the consensus is at a loss of $1.18 that year, and we think that estimates will need to come up materially.