There’s an odd psychology that arises with stocks like JCPenney (OTCMKTS:JCPNQ) that head into bankruptcy. Some investors convince themselves the stocks are “cheap.” We’re seeing a bit of that now with JCP stock (I’ll use the old ticker for simplicity’s sake).
After all, the stock price certainly looks cheap. JCP stock, for instance, closed Monday at just 21 cents. Think how many shares an investor can own!
There will be arguments that there’s some sort of hidden value that can be found in the bankruptcy process. Of late, I’ve seen that case being made for JCPenney.
Or there are accusations of incompetent management — or worse, malfeasance. From that perspective, the problem isn’t JCP stock, or JCPenney itself; it’s the executives.
But there’s no magic coming, no “Hail Mary” comeback for JCP stock. The story isn’t that complicated. The world changed. JCPenney didn’t. And so a once-great retailer, like others, is heading into bankruptcy.
That in turn means the stock is headed toward zero — even if there may be some rallies on the way.
Watch for a Head Fake
Up front, I’ll say this: JCPenney’s stock may rally. Many stocks in a similar position have done so.
The most obvious comparison at the moment is Sears Holdings (OTCMKTS:SHLDQ), which still sees trading almost two years after it declared bankruptcy. Over that stretch, SHLDQ has seen several rallies.
The stock actually doubled after bankruptcy was declared. Starting at the end of 2018, it rallied a staggering 1,000% in a month and a half. Unsurprisingly, the stock collapsed soon after.
Last Wednesday, Hertz (NYSE:HTZ) gained 122%. It has lost 32% since. Tuesday Morning (NASDAQ:TUES) saw a huge rally last week, just days after filing for bankruptcy; that rally has been all but erased.
These moves are being driven by traders, not investors. And those traders may have some fun with the former JCP stock as well. But short-term moves, should they arrive, don’t erase the longer-term problem.
Understanding the Debt Problem for JCP Stock
The problem for JCP stock is not necessarily that JCPenney can’t make money. It had until recently: free cash flow in fiscal 2019 (ending February 1, 2020), for instance, was $145 million.
It’s not that JCPenney has no assets. The operating business has some value. JCPenney still owns some real estate (though it has executed so-called sale-leaseback transactions on some property to raise cash).
The problem is that the liabilities are worth more than the assets. Again, the assets aren’t worth nothing. They’re just worth less than the $3.5 billion in long-term debt with which JCPenney closed fiscal 2019.
Meanwhile, the novel coronavirus pandemic created a significant drain on cash — and JCPenney has no way to access more. The debt markets aren’t interested in lending the company more money. It couldn’t raise much by selling equity, even when JCP stock traded above $1 at the beginning of the year.
Put another way, coming into 2020 JCPenney didn’t have any room to manage a downturn. It wound up running into the biggest short-term headwind U.S. retail has ever seen.
Listen to the Judge
When a company files for bankruptcy, its equity doesn’t always wind up worthless. Sometimes, shareholders wind up with a small amount of equity in the new company. On occasion, it turns out the assets have more value than the liabilities, leaving residual funds for stockholders.
Neither scenario seems particularly likely in the case of JCPenney. The company did close fiscal 2019 with a book value of $829 million. That’s over $2 per share. But if an investor discounts inventory by 50% — conservative in a liquidation scenario — the value disappears.
And it’s hard to imagine a bidder coming in to acquire JCPenney for more than its debt. Macy’s (NYSE:M), with much higher revenue and profits, has a market capitalization of barely $2 billion at this point. And that’s with valuable real estate in markets like New York and San Francisco.
There may still be a JCPenney going forward. After all, bankruptcy is not the same as liquidation. But that’s not what matters for JCPNQ stock.
What matters is what’s left over for shareholders once the bankruptcy process plays out. And it’s hard to imagine that figure being anything greater than zero.
Indeed, investors should listen to the bankruptcy judge overseeing JCPenney. As he put it, “No one ever loses equity in a bankruptcy case. Equity gets lost long before the bankruptcy gets filed.” That’s exactly what happened here — and that equity value is lost for good.
Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. The power of being “first” gave Matt’s readers the chance to bank +2,438% in Stamps.com (STMP), +1,523% in Ulta Beauty (ULTA) and +1,044% in Tesla (TSLA), just to name a few. Click here to see what Matt has up his sleeve now. Matt does not directly own the aforementioned securities.
