Yesterday, it was Goldman [7]which (paradoxically, considering the firm's role in the recent Term Loan underwriting) took the axe to JCP securites, both bonds and stocks. Today, following news that JCP is considering a $750MM-$1Bn equity raise [8](of course it is - it is considering every possible option, including asset sales, a second lien and of course, a bankruptcy) which we believe if anything would be in the form of a rights offering as we commented yesterday...
$8 seems like a fair TERP for a JCP rights offering
— zerohedge (@zerohedge) September 26, 2013 [9]
... it is the turn of Citi's Deborah Weinswig which after reviewing its JCPenney cash burn analysis, goes for the jugular with phrases such as "We think adequate cash for 2014/2015 is in question", "The turnaround is taking longer than we anticipated, and we are concerned about a softening macro environment combined with deteriorating vendor relationships", and of course "We maintain our EPS ests. but are lowering our target price to $7, down from $11 prev., based on an EV/Sales valuation methodology using our 2015 sales estimate." And it gets worse: "Where’s The Floor? — As a supplement to our EV/Sales valuation methodology, we have conducted a basic liquidation valuation, yielding $324M total value, or $1/share." Well, as long as there is a "floor"...
The highlights:
Where’s the Floor? Reiterating Sell; Lowering Target Price
Our Take — We are revisiting our cash burn analysis following recent meetings with other retailers and vendors. We still believe JCP has ample liquidity for 2013, but we do think it prudent for them to raise capital to cushion against a potentially challenging Holiday season (six fewer days, C.H.E.A.P. consumer, loss of a weekend YOY, etc.). We think adequate cash for 2014/2015 is in question. The turnaround is taking longer than we anticipated, and we are concerned about a softening macro environment combined with deteriorating vendor relationships (due to weak volumes and growing anxiety about on-time payments during and after Holiday). We reit. our Sell rating and lower our target price to $7, vs. $11 prev.
Lowering Target Price — We maintain our EPS ests. but are lowering our target price to $7, down from $11 prev., based on an EV/Sales valuation methodology using our 2015 sales estimate (unchanged). We assign JCP a ~0.45x EV/Sales multiple on our 2015 sales estimate (vs. 0.5x prev.). Our assigned target multiple is in-line with JCP's historical median EV/Sales multiple of 0.43x, vs. slightly ahead previously, as we believe the turnaround is taking longer than expected.
Where’s The Floor? — As a supplement to our EV/Sales valuation methodology, we have conducted a basic liquidation valuation, yielding $324M total value, or $1/share.
What Could Raise the Roof? — One of the risks to our Sell call is JCP attracting mgmt. talent in the near term. There have been over 10 senior-level mgmt. exits since Ron Johnson left in April. JCP is operating with a “Swiss cheese” executive team, and we believe they continue to have difficulty attracting talent. Another risk is a better than anticipated Holiday season. We forecast SSS of (-7.5)% in 3Q13 and (-2.0)% in 4Q13, and these ests. reflect a consistent 2-year stack throughout 2013. Our meeting with KR mgmt. this week supports our view that consumers are putting more of their discretionary $$ towards big ticket purchases like homes and cars.
Where's the Floor?
Our 12-month $7 target price for J.C. Penney (JCP) is based on an EV/Sales valuation methodology using our 2015 sales estimate. We assign JCP an approximate 0.45x EV/Sales multiple on our 2015 sales estimate, which results in a price target of $7. Our assigned target multiple is in-line with JCP's historical median EV/Sales multiple of 0.43x. We believe that the stock will be driven by topline trends, as investors will likely use sales growth as the primary gauge to evaluate the company's turnaround progress.
As a supplement to our EV/Sales valuation methodology, we have conducted a basic liquidation valuation (Figure 1). Taking our estimated real estate value (see Figure 4), plus current inventory value less merchandise accounts payable and net debt, we arrive at $324M total value, or $1 per share.
[10]
We note that the valuation does not reflect JCP’s forward looking cash burn. Should the company continue to burn cash, as we expect, the value per share would decrease (refer to Figures 2 and 3). We also have not discounted the inventory value to reflect any potential clearance, not included $1.35B of other accounts payable and accrued expenses, and not accounted for costs to unwind the business.
JCP Cash Burn Analysis
We have updated our JCP cash burn analysis as follows: Ample Liquidity for 2013 (with 2014 Still in Question)
Ample Liquidity for 2013: Management believes JCP will not need a capital infusion this year, and also believes that the company has ample liquidity for 2013. Our analysis doesn’t indicate that the company would need to pursue a debt or equity offering to shore up liquidity in the near term. However, if cash burn is running worse than our expectations, then JCP may need to raise capital to cushion against a potentially challenging Holiday season. We are forecasting a net increase in cash of +$501M in 2013, driven by JCP’s $2,180M term loan and $850M of revolver borrowings, offset by a decrease in operating cash flow of (-$1,266)M and capex of (-$950)M. We expect the company to end the year with $1,431M of cash on the balance sheet, which is more than adequate to fund its operations.
But Operations Are Eating Up Cash: We expect a significant decline in FCF (before financing) of (-$2.1)B for 2013. This level of cash burn is concerning and not sustainable.
Cash Burn Persists in 2014: For next year, we are forecasting a (-$132)M net decrease in cash. This reflects a use of cash from operations of (-$507)M, capex of $300M (which honestly seems way too low to us, but is an estimate provided by the company), and no incremental debt financing. We are forecasting a cash balance at year-end of $1,299M, which is still above the $500-750M that we estimate that JCP needs on hand to run its business. However, if our forecasts play out, we think investors will still be concerned with the negative cash burn for the year. Please see Figure 4 for a sensitivity analysis illustrating the ramifications of operating results below our estimates, should same-store sales fall short of estimates and the company resorts to higher-than-expected levels of clearance.
Relief in 2015?: We expect cash levels to slightly rebound in 2015, with a +$51M net increase in cash. However, our estimate is highly sensitive to samestore sales trends, and will heavily depend on how quickly the turnaround can be executed and the company can return to positive comps. We believe a lackluster Holiday 2013 season could put a 2015 recovery in peril.
[11]
JCP Real Estate Valuation
RE Value of $4.1B (versus our estimate of $2.7B detailed below) Doesn’t Cover Net Debt of $4.3B
Cushman & Wakefield (C&W) valued the company's real estate at $4.1B ($3.3B for the stores + $0.8B for distribution centers and headquarters). The $4.1B real estate value is slightly below the company's estimated net debt of $4.3B at year end. We believe C&W's valuation at approx. $65/sq. ft. for owned stores could be optimistic.
We value JCP's total real estate at $2.7B, using an assumption of $50/sq. ft. for owned stores. The median historical price per square foot for comparable department store sale transactions is $48 per square foot, according to CoStar. We question the value of stores in C/D tier malls (63% of total stores by our estimate), as many of these malls are declining in importance and demand from other retailers to open in these malls is low.
Our real estate valuation by comparable department store real estate transactions yielded a real estate value of $2.4B for JCP's stores and $0.3B for distribution centers, for a total value of $2.7B. Please see the figure below for more detail.
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But tell us how you really fell Deborah. As for JCP, we can imagine where it goes from here. It doesn't fix the cable...