Takeaway: This is going to be the quarter where people look back and say “yeah, that was the point where I should've realized JCP's a viable entity.”
Editor's note: This research note was originally published November 21, 2013 at 08:14 in Retail by Hedgeye Retail analyst Brian McGough. JCP is up 4.5% since then.
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 are 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.
See our note below for more details about our call, or contact us for our recent Black Book. Also look out for our updated survey the week following Black Friday.
Here are some of our recent clips from HedgeyeTV. Comments are welcome, as always.
HERE’S WHAT WE SAID WE WERE LOOKING FOR OUT OF THE QUARTER.
11/19/13 11:49 AM EST
JCP: Buy The Event
Takeaway: There are many possible outcomes from JCP’s print. But there is virtually nothing JCP can say to suggest that it is not 100% fixable.
Conclusion: One of two things will happen, either we’ll get tangible evidence of the turnaround – which will make JCP worth buying even if it’s up. Or the company will ‘pull a JCP’ and scare the Street with the print, as it has grown so accustomed to. We think that’s unlikely. But we think one thing is clear, there is virtually nothing the company can or will say to suggest that this company is not 100% fixable. We’re buyers on the event.
First off, let’s be clear about where we stand on JCP. Our positive call is based on our view that not a single thing currently ailing JCP is beyond repair. This company is not broken. Johnson bullied and bruised a few dozen critical functions at the company, and though he may have tried to break them, he failed at that too. We don’t think that Ullman is the right person to rehabilitate JCP, but he is the right guy to take it off life support and administer CPR if necessary. We expect to see a new CEO announced by Spring 2014.
Another important point..we’re not arguing that JCP is a great retailer, a great brand name, or in any way deserving of the right to exist as a go-to source for consumers.
But let’s keep an important factor in mind…it’s 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 out 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 the $140/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. Note that Ron Johnson’s decimation of JCP’s private label brands 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 with $900mm at a 33% gross margin.
All in, those assumptions get us to $1.30 per share, which is meaningfully above the high end of where even the most vocal bulls (if there are any) are posting their estimates. Will it get there tomorrow? No. But it’s math that people will begin to run within 12-month’s time. Keep in mind that over the past few years there has always been a debate alive about what the ultimate earnings power of JCP actually is. That debate today is absolutely dead. And we’re not talking about an unachievable Ackmanist-driven Hail Mary $12-EPS power. In all our travels and phone calls, we can’t find anyone that is willing to acknowledge that JCP can actually earn money. That will change, and we think it happens within 12-months.
So, what are we looking for in the quarter?
- First off, this is literally a three-year turnaround – it won’t be fixed in a quarter. What we’re looking for this quarter is a mere two or three wins on the road to fixing several dozen problems. That might sound like a shameless hedge – perhaps it is. But there’s going to be a mix of noise and good news in this quarter. That’s upside from the past two years where it’s been all bad news.
- We’re looking for about a -5% comp. The company already reported a 0.9% store comp and 38% dot.com comp for Oct. Based on commentary by virtually all retailers, October was the best month of the quarter. -5% seems about right, but could be 2-3% +/-.
- Gross Margin change is going to move inversely to comp. We have it modeled +100bps vs. last year – which would mark the first GM improvement in about 10 quarters. Our bias is to the downside on that one, as Ullman told the whole world that he’d end the quarter with positive comps, and he did a +0.9% in Oct. Sounds like he stretched. More likely than not, he told his selling and merchandising team to drive a positive comp come hell or high water. That usually does not come alongside a healthy gross margin. Nonetheless, they’re coming off such low numbers that Gross Margins could be down 100bp and still post a 150bp sequential improvement on a 2-year run rate – which is what we’ll really be looking to see.
- We’ve got an operating loss of -$292mm, which compares to the Street at -$384mm. Our number might be on the aggressive side due to gross margin, but we’re reasonably confident that JCP won’t miss the consensus.
Usually, we don’t leave EPS for last, but the company’s print relative to expectations will be relatively meaningless due to the timing of the company’s offering and inconsistency in how people are modeling the fully-diluted share count. The Street is at -$1.70 this quarter, but the range is from -$2.36 to -$1.11. We have JCP losing a little over a buck. But again, share count is uncertain. We’ll look at the operating loss delta as the best way to gage our estimates versus consensus.
"I often wonder how far I'd go for love. I guess it all depends on the price of gas."
We will be hosting an Expert Call featuring Tancred Lidderdale from the Energy Information Administration (EIA) for an in-depth discussion on the outlook of oil and natural gas.
The call titled "Oil & Natural Gas: Supply, Demand, Prices and Trends" will be held TODAY, November 26th at 11:00am EST.
- Toll Free Number:
- Direct Dial Number:
- Conference Code: 658898#
- Materials: CLICK HERE
KEY TOPICS OF DISCUSSION WILL INCLUDE:
- Key variables that drive the price of oil
- Expectations for 2014 supply and demand
- OPEC's ability to impact price
- Why OPEC's surplus capacity is growing
- Declining U.S. oil demand
- Natural Gas
- Intermediate supply outlook for natural gas
- Current natural gas supply versus historical level
- Drilling and drilling productivity
- Outlook for the renaissance in U.S. natural gas
- Current and future natural gas demand
- Expectations heading into 2014 for demand and supply
- Longer term trends
- Price set versus the price of crude
- Price implications from the spread on WTI/Brent
ABOUT TANCRED LIDDERDALE
Tancred Lidderdale is the supervisor of the team that produces the Short-Term Energy Outlook for the Energy Information Administration (EIA). Before joining the EIA in 1991, he worked for 12 years with Atlantic Richfield Company in their petrochemical and refinery operations, and foreign crude oil trading. He received his B.S. degree in Chemical Engineering from Georgia Tech, his MBA from the University of Houston, and his Ph.D. in Economics from George Mason University.
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Client Talking Points
The European Central Bank (ECB) bureaucrats have to be miffed. In spite of the rate cut, and French and Italian jawboning, the EURO just won’t go down. Why? It's primarily because the US DOLLAR won’t go up! Meanwhile, Janet Yellen is the more incremental dove here. The ECB’s balance sheet doesn’t look like the Fed.
"Putin Power" (or lack thereof) is turning into an interesting story yet again as the price of Oil makes a series of lower-highs and Ukrainians go after the pro-Russia central planning thing. The Russian stock market leads the losers this morning down -0.8%. Old Putin's market is down over -3% year-to-date. Live by oil, die by oil...
The 10-year yield is down 4 basis points to 2.72% in the last 24 hours. Gold goes up $20/ounce on that. Getting #RatesRising right had you get Gold (down) right. The question now is does Gold stabilize as yields make lower-highs?More to be revealed.
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Top Long Ideas
Our bullish call on the British Pound was borne out of our Q4 Macro themes call. We believe the health of a nation’s economy is reflected in its currency. We remain bullish on the regime change at the BOE, replacing Governor Mervyn King with Mark Carney. In its October meeting, the Bank of England voted unanimously (9-0) to keep rates on hold and the asset purchase program unchanged. If we look at the GBP/USD cross, we believe the UK’s hawkish monetary and fiscal policy should appreciate the GBP, as Bernanke/Yellen continue to burn the USD via delaying the call to taper.
WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.
Financials sector senior analyst Jonathan Casteleyn continues to carry T. Rowe Price as his highest-conviction long call, based on the long-range reallocation out of bonds with investors continuing to move into stocks. T Rowe is one of the fastest growing equity asset managers and has consistently had the best performing stock funds over the past ten years.
Three for the Road
TWEET OF THE DAY
I have never seen so many market geniuses be bearish on a market they can't time @KeithMcCullough
QUOTE OF THE DAY
"To think is easy. To act is hard. But the hardest thing in the world is to act in accordance with your thinking." - Johann von Goethe
STAT OF THE DAY
About 1 in 6 unemployed workers are addicted to alcohol or drugs -- almost twice the rate for full-time workers, according to the government's National Survey on Drug Use and Health. The survey shows that 17% of unemployed workers had a substance abuse disorder last year, whereas 9% of full-time workers did so. The numbers are self-reported, and therefore, could be even higher in reality.
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