JC Penney's Long-Term Headwinds Might Just Be Too Bad

Shares of J C Penney Company Inc JCP were trading higher during Monday's pre-market session despite bearish research notes issued by analysts at Morgan Stanley and UBS following its second-quarter print last week.

Morgan Stanley: Encouraged By Progress, 2016 And Beyond A Question Mark

Kimberly Greenberger of Morgan Stanley commented in a note that JC Penney's second-quarter results demonstrated "encouraging" progress and sales "momentum." Specifically, comps rose 4.1 percent in the quarter (exceeding the analyst's 3.5 percent estimate) and demonstrated sequential improvement on both a one- and two-year stack.

Greenberger also noted JC Penney's 330 basis point decline in SG&A was impressive and demonstrates the company "clearly has momentum" heading into the back end of 2015. The analyst added that the company's back half guidance also implies a "slight improvement" from the 3.5-4.0 percent comp run-rate in the first half of the year, but the question remains if the company can "continue to distance itself" from a "challenged" landscape.

Related Link: JC Penney Heads Towards $9 Off Q2 Beat

Moreover, Greenberger suggested that the company's full year 2015 gross margin estimate of roughly 36.0 percent implies a 400-500 basis point recovery from 2012. However, JC Penney's guidance for the second half of 2015 (70-100 basis points of gross margin improvement) is "more conservative" and could hint that further improvement in 2016 and beyond will be "less robust."

In fact, Greenberger argued that JC Penney's equity value rests on incremental EBITDA growth from 2016 to 2018. Under a "bear" case scenario, the analyst estimated the company will reach $1.06 billion EBITDA by 2018 while a "bull" case scenario brings the company's EBITDA to $1.6 billion by 2018.

Bottom line, the analyst is sticking to a "bear" case assumption for the time being based on what she considers to be management's "cautious" views and a lack of "visibility" over the long-term story.

Shares remain Underweight rated with an unchanged $6 price target.

UBS: Multi-Year Headwinds Remain

Michael Binetti of UBS offered a similar analysis in a note, commenting that JC Penney is off to a "solid" start in the third quarter and can benefit from lapping a flat year-over-year same-store sales compare.

However, Binetti is "hesitant" to assume that J. Penney's new initiatives (i.e., Home) will prove to be sufficient to drive multi-year same-store sales gains as the company will begin lapping more "normalized" multi-year compares by the fourth quarter.

In addition, Binetti argued that JC Penney's "elevated" inventory levels could add pressure on gross margins in the bottom half of the year.

Bottom line, the analyst remains "hopeful" that recent momentum can carry forward through 2017, a "more visible" and "sustainable" path towards consistent share gains and free cash flow generation is needed before "embracing" a bullish thesis.

Shares remain Sell rated with an unchanged $7 price target.