JP Morgan: J.C. Penney Stands At 'Pivotal Crossroads'; Now A Good Time To Buy Shares

J.C. Penney's JCP turn-around story continues to gain momentum as analysts at JP Morgan on Monday released a positive note suggesting shares should be considered as a “fall fever long trade.”

“The J.C Penney story stands at a pivotal crossroads with today's mid-single-digit top-line pace of recovery questioned versus the 33 percent revenue drop the past three years,” Matthew Ross of JPMorgan wrote in a note to clients on Monday.

Ross continued, “While we were encouraged by the second quarter's top-line/gross margin algorithm [6 percent same-store sales gain and 650 basis point improvement to gross margins], J.C. Penney's promotional cadence has returned to fiscal 2011 levels with heightened smaller market competition (particularly with a localized/Omni-Channel Macy's fleet) increasing the likelihood for structural optionality over the next 12 months in our view.”

Related Link: Mark Hake Of Capital Management Sees Bright Future For JC Penney

According to Ross, J.C. Penney operates with components of its expense base commensurate to its fiscal 2006 $20 billion revenue base, presenting a “material leverage constraint.” Additionally, SG&A expenses are currently at a sales base below $15 billion.

Ross Further Crunches Up The Numbers And Concludes:

"Herein, we layout an EBITDA accretive restructuring road-map using J.C. Penney's 33 store closings in fiscal 2014 as a base ($65 million of cost savings) with our pro-forma analysis pointing to an EBITDA dropdown of ~$1.5 million per store (ex one-time closing costs) resulting in a more productive, margin accretive, and free cash flow positive aggregate store fleet into fiscal 2015."

Bottom Line, According To Ross: 

“Net/net, with new management, a new potential analyst day catalyst and store base consolidation likely post year-end (every 100 store closing = $150 million EBITDA or $3 Equity Value) answering the “tougher compares” fiscal 2015 bear case argument, Neutral-rated J.C. Penney sets up well for a long trade through year-end, in our view.”

Looking forward to fiscal 2016, Ross is projecting J.C. Penney's "base case scenario" will be comprised of $13.6 billion in sales, 37.5 percent gross margin and an SG&A 34.3 percent of sales.

A level of SG&A being below 30 percent of sales is not feasible with revenues under $15 billion given the company's advertising, occupancy/rent and payroll structurally at 2011 levels today. The analyst noted that J.C. Penney's is not expected to reach the $15 billion mark until fiscal 2018 based on Monday's mid-single-digit growth pace.

Ross notes that a large scale restructuring of at least 100 store closures is “likely” post-year end with a possibility of returning to 2006 peak levels of 39.3 percent gross margin, an SG&A being 29.6 percent of sales and upside case of 10 percent EBIT margins given $1 billion in permanent expense reductions.