Potential double-dip recession notwithstanding, I’ve started paying close attention to retailer J.C. Penney (NYSE:JCP). I originally wasn’t all that impressed with the stores themselves, as they felt like cheap versions of higher-end department stores. But that has proven to be a mistake, because not only was my impression wrong, it blinded me to the many great reasons to own the company’s stock. Then I learned that fellow Horace Greeley High School alum Bill Ackman, founder and CEO of Pershing Square Capital Management, took a sizable stake in J.C. Penney, joined its board, and hired a big executive away from Apple (NASDAQ:AAPL).
Ackman’s thesis is multipronged. One big element is J.C. Penney’s real estate assets, which may be a reason why
Vornado Realty Trust (NYSE:VNO) also has purchased a large stake. Penney owns some 41 million square feet of its retail space, its Texas-based headquarters, as well as the 240 acres surrounding it. This real estate is not only failing to generate any actual income, it is costing the company money in various impairment charges. Clearly there is value to be unlocked here. That Vornado is now involved is a signal that its management sees this value as well. Spinning off the real estate portion into some kind of real estate investment trust, or creating a sale-leaseback transaction, would help unlock that value.
Friday’s close had shares at $28.37, which is only 40% above Ackman’s initial buy-in, and 30% off its high of $40 (On Monday, amid the market’s continued selloff, the stock was off more than 8% to just above $26). Based on Friday’s close, the P/E ratio of 14.3, on 2011 earnings per share of $1.97, puts it in range of its peers. However, Ackman felt the shares were undervalued at $20, making it “cheap relative to trailing earnings” (adjusted for year-end cash and non-store real estate portfolio). And, as he pointed out, the stock currently trades at only 4.9 times 2010 pretax earnings.
In the trailing twelve months (TTM), J.C. Penney had revenue of $14.77 billion and net income of $393 million. Ackman has also noted that pension expense, which appears on the cash flow statement, masks the true cash flow being generated by the company. Indeed, backing out Penney’s approximately $120 million of pension expense, TTM free cash flow is $1.22 billion. The company also is sitting on $2.6 billion in cash, or almost $12 per share!
Ackman is invested “because of its inexpensive valuation, strong brand name and assets, and well-deserved reputation for overseas sourcing, high-quality systems, and large in-house brands.” After examining the company, I am siding with him on this investment. With a chance to buy in close to his own price, and confident this will not turn out to be another Borders (NYSE:BGP), I am keeping a close eye on Penney and watching to see if it moves lower.
Lawrence Meyers does not own any companies mentioned in this article, but JCP is on his watchlist.
