If there’s been one lesson in the apparel retail sector over the past few years, it’s that stocks have never been “too cheap.” Any investor considering J C Penney Company Inc (NYSE:JCP) stock, with the JCP stock price at an all-time low, should heed that lesson.
Of course, JCP stock doesn’t even look that cheap anymore. It did a week ago, when a price above $3 and full-year EPS guidance of $0.40-$0.65 suggested a forward P/E multiple under 7x. But after sharply lowered Q3 guidance was released on Friday, full-year guidance was cut to $0.02-$0.08.
To be fair, free cash flow guidance still sits at $200-$300 million, which sounds like a hugely attractive figure against a market cap of just over $1 billion. But debt, margin pressure and industry trends all mean that JCP isn’t close to “too cheap.”
Q3 Guidance for JCP Stock
JCP stock fell nearly 15% on Friday after the updated guidance was released. It tacked on another 8% drop on Monday as the selloff continued, and analysts at Citigroup Inc (NYSE:C) cut both JCP and rival Macy’s Inc (NYSE:M) to “Sell.”
The selloff doesn’t look like an overreaction. Analyst consensus was for a Q3 loss of $0.18. Instead, JCPenney expects an adjusted loss of $0.40-$0.45. The company attributed the weakness to liquidation of inventory in the women’s apparel business, but it also cited e-commerce and appliance sales as hitting margins.
Full-year EPS guidance was pulled down, as noted, and free cash flow now is guided to $200-$300 million against a previous $500 million. Same-store sales now are guided to be flat to down 1% for the full year, after flat sales in fiscal 2016 and 4.5% growth the year before. Gross margin is expected to compress 100-120 basis points.
It’s just bad news across the board. And the problem is that the numbers in Q3 aren’t just a matter of one problematic quarter. Rather, they highlight the challenges for JCP stock going forward.
Retail Problems for JCPenney
The narrative that brick-and-mortar retailers are simply losing share to Amazon.com, Inc. (NASDAQ:AMZN) doesn’t tell the whole story. There are other concerns in the department store space in particular, among them mid-single-digit declines in mall traffic that may be partially, but not totally, attributable to e-commerce. JCP has actually done a good job on same-store sales on a relative basis. It’s clearly taking share from Macy’s and outperforming most retailers in this climate.
The problem is that while flat sales might be better than those of rivals, it still simply isn’t good enough. Labor, rent and health care costs mean that flat sales — as JCP is struggling to post this year — still mean declining profits. JCP managed to grow profits last year on flat sales thanks to cost cuts, but that can’t last forever.
In that context, the FY17 guidance is even more concerning. As noted in the preliminary Q3 numbers, efforts to boost sales by adding appliances and boosting online revenues are hitting gross margins. Full-year guidance suggests gross profit dollars will be down 2%+ this year. Both appliances and e-commerce are part of the long-term top-line growth strategy here, but they are compressing margins at the same time.
All told, profits are declining, and for that to stop, JCPenney has to reverse its comp decline. But how? Hardly anyone in the brick-and-mortar space — and no one in the mall space — has been able to stem those declines. Even with the benefit of liquidation sales this quarter, comps still dropped. Unless that changes, EBITDA growth will turn negative going forward. And EBITDA declines mean that the JCP stock price is heading to zero, even if it takes a while.
Debt Problems for JCP Stock
Admittedly, the situation at JCP isn’t as bad as it is at Sears Holdings Corp (NASDAQ:SHLD), where bankruptcy looks like a very real possibility in the near term. But even $1 billion in equity value looks like too much.
It’s true that free cash flow of over $200 million this year looks attractive. But that free cash flow is going to bondholders, not stockholders. And as I wrote a little over a week ago, that will be the case for some time. JCPenney has to repay at least the $1.65 billion on its term loan before it can issue a dividend or repurchase shares. At the current pace, that would take a minimum of six years. And if free cash flow declines, that day might not ever come.
Bear in mind that JCPenney bonds are trading as low as 63 cents on the dollar and yielding over 12%. Both figures suggest a material chance of bankruptcy over the long term. And in the near term — as in several years — shareholder returns will be zero. (Note too that investors interested in timing the bottom in JCP stock might get a better deal, with more potential recovery value in a bankruptcy, through those bonds.)
The current performance simply isn’t good enough. That was true before Q3, and it will be true after Q3. JCPenney needs a substantial inflection in its business to survive long enough to create any value for shareholders. There’s zero evidence in the recent numbers to suggest that inflection is coming.
As of this writing, Vince Martin has no positions in any securities mentioned.
