Friday, May 18, 2012

JCP: Johnson Premium Gone

So JCP tanked this week on bad earnings; it closed the week at $26.29/share.    I think this is an interesting situation but haven't done anything here yet, but things are getting interesting at this price.


The Situation
I assume most people in the market knows what's going on here.  Bill Ackman of Pershing Square along with Vornado Realty (REIT with real estate assets in NYC, Washington DC and others) bought a big stake in J.C. Penney to turn things around.  Last year they hired Ron Johnson, the guy behind the hugely successful Apple stores and was a factor in the success of Target.

They did a big presentation early this year laying out their plan to turn JCP around.  I posted some comments on that here:

Part 1
Part 2


The Johnson Premium
So the point now is that the stock price decline has pretty much taken out the Johnson premium and then some.  When he came on board, the stock price popped.

The announcement of his hiring came on June 14, 2011.  The stock closed on the day before that at $30.11/share.  After the announcement, the stock price closed at $35.37/share.

On January 25, 2012, JCP held a big meeting to present their new plan.   I think Ackman called this the most important day in retailing or some such.  The stock price on January 25, 2012 closed at $34.28/share and on January 26 it closed at $40.72/share  (This was actually the second day of the investor presentation when they announced the financial details).

So you can say that the JCP stock price of $30-35 is really the pre-plan-announcement JCP price.  $30 is the pre-Johnson-hire price. 

The JCP stock price is now trading BELOW the price on the day before it was announced that Johnson was hired and below the pre-presentation price.  In other words, the Johnson premium, or the Johnson plan premium is now more than gone; it's a Johnson discount.


JCP Floor Price
The above can be sort of a floor price (well, not a real floor as obviously Johnson can make things worse, the economy can get worse, the decline at JCP may continue etc...) on JCP stock, especially when looking at JCP as an event trade; will Johnson succeed or not?   "Yes" would take the stock up, and "no" would leave it stuck where it was before he came on board.

Another way to look at it is to assume, in the case of failure, that JCP will just muddle along as it has in the past five years.

The adjusted EPS (exclude charges and pension expenses) over the past five years were:

               JCP adjusted                  Operating
               EPS                                margin
2007       $4.63                              9.0%
2008       $2.17                              5.4%
2009       $1.86                              5.5%
2010       $2.24                              6.1%
2011       $0.94                              3.1%

average:  $2.37                              5.8%

So if JCP just muddles along as it has in the past five years, it may earn $2.37/share and on that, JCP stock is trading at 11.0x p/e.  All you need for this stock to be at 11x earnings is for JCP to do sort of what is was doing in the past five years.

OK, so sales have been declining so this five year average may be no good.  So let's assume that cost cutting and other things will keep operating margins around where it has been in the past five years; that's 5.8%. 

2011 sales were $17.3 billion (I know it dropped a lot this past quarter, but let's assume that is due to many big changes, inventory adjustments and other things going on now so may be temporary).  Assuming no growth in sales and a 5.8% margin, that's $1 billion in operating income.  Take out $227 million in net interest expense (2011 amount) for $773 million in pretax income and $464 million in net income.  With 218 million shares outstanding, that comes to $2.13/share.

So if sales can be maintained at the 2011 level and they can earn a 5.8% operating margin, that's $2.13/share in EPS and on that, the stock trading at 12.3x.  So that's not bad at all.  All they need to do is maintain sales and get a 5.8% margin.  Anything on top of that is a bonus.

Put a 10x multiple on the five year average EPS of $2.37 gives us a floor price of $23.70/share and a 10x multiple on the $2.13/share EPS derived above gives us $21.30/share. 

So let's say the Johnson non-success, fail price is around $21.00-24.00/share.  At $26/share, we are not very far from it.

Of course, I understand that a real failure may lead to further sales declines and actual losses.  So this isn't really a floor, floor.  It's just a reference point.

Upside
So anyway, Ackman said that JCP could earn $6.00/share in EPS by 2015.  At 10-15x p/e, that could lead to a stock price of $60 - 90/share. 

I haven't seen the actual presentation that Ackman made at the recent conference, but some reports have said that Ackman said JCP could be worth from $191 to $315/share.  JCP has sales per square foot of $132, but if they can get that up to $250/sf, JCP would be worth $191/share and it could be worth $315/share if sales got up to $350/sf.

That really sounds like a stretch.  Sephora boutiques inside of JCP stores have sales per square foot of $600, but I imagine that's quite a bit different than your typical department store space (apparel etc...).

It seems they believe that the store-within-a-store concept is going to really bump up those sales per square foot figures and drive traffic (Martha Stewart etc...).

Ackman apparently stressed that the key here (as if people didn't get it) is that it's is substantially cheaper for brands to have a store inside of JCP than in a separate space in a mall.

Anyway, those are Ackman's upside values.

To use more conservative figures, let's assume that JCP can keep sales flat with 2011 and then achieve 8% and 10% operating margins.

This is what they can earn with these operating margins (assuming 218 million shares outstanding, $227 million net interest expense and 40% tax rate):

                                    EPS                  Stock price range at 10-15x p/e
8% margin                  $3.18                $31.80 - 47.70
10% margin                $4.14                $41.40 - 62.20

(actually, with both Macy's and Kohl's trading at 10x or so p/e, there may be no reason to look at 15x valuations here, unless the JCP turnaround really starts to work)

Conclusion
At the very least, JCP stock has come down to the Johnson hire pre-announcement price so any premium attributed to the Apple magic is competely gone at this point.  The above shows that JCP is priced reasonably even if nothing exciting happens going forward.  If they just muddle along, the stock is priced within reason (or slightly on the high side).

However, if this turnaround starts to work, there can be substantial upside. 

Of course plenty can go wrong with this too.  But I don't think this is another Sears; JCP is now being run by a bunch of retailers, not finance people.

I think it's wrong to evaluate Johnson when he is just starting out.  He is trying to make a lot of changes at once so it's understandable that things are going to be tough until they get on track.  You don't sign a star to play for your team and then evaluate his performance after one or two games!

Let's see how this unfolds.

I do not own JCP at this point, but may in the future.  This may be one of those things you can play as a binary bet via longer term options; you bet that Johnson will succeed and don't worry about what happens in the short term.

The risk/reward ratio now with JCP at $26 is attractive also as a simple long as the upside can be $34/share (10x $6.00 eps in 2015) and downside of $2-4/share (you can plug in your own figures to get upside/downside ratios).

1 comment:

  1. Good analysis once again. However, I can think of a case in the past where a retailer turned it around. Are you aware of one? You would figure GAP, limited, Sears would have figured out something by now. I wonder how much the JCPenny real-estate is worth. If they are mostly in malls, I guess they probably just leasing. It will be interesting.

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