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Thursday, January 26, 2012

JCP - good risk/reward

Day two of the JCP meeting was a very interesting one.  Management gave good details on the financial front, that gave a lot of certainty letting the stock to pop rather nicely.

The numbers:

JCP told investors a few important things:

1. Expenses (in relation to sales) will decrease to 27% by the end of 2015.

2. They will cut $900M in expenses over the first 2 years.

3. Traditional metrics (same store sales, guidance and quarterly sales) are thrown out the window. (Looks like all new management cares about is profitability. Also, with the mantra of merging online and brick-and-mortar sales, many traditional retail metrics are simply irrelevant.)

4. EPS for 2012 will meet or exceed 2010 GAAP 1.59 eps. (I am only going to focus on GAAP earnings for this analysis.)

5. Self funded transformation. ($800M in Capital Expenditures in 2012.)

Yesterday, I thought the street would react negatively with the $800M capital expenditure, but the cost savings initiative overwhelms the added costs.

Working out the numbers, I find myself impressed. Using 2010 numbers as the bases case, as management has done with respect to eps guidance (#4), its fairly obvious operational income is projected to grow nicely.

A few notes regarding the above numbers:

1. Conservatively assumes zero revenue growth. (This was done because from 2008-2010 revenue declined, hence a conservative measure is simply prudent.)

2. Operational Expenses in relation to Sales was spread evenly over the 2015 time period.

3. Gross Margins remained constant. (This is really conservative. GM will increase as $900M expenses are removed.)

4. With the lack of GM increase, the total $900M is not factored in. (Again, this for the sake of being very conservative.)

With very conservative estimates, Operational Income still increase significantly from 2012 to 2015.  Applying these growth rates to a realistic EPS and trailing PE projections, JCP can potentially trade near mid 60.

The only thing that may hinder this year's eps is the $800M cap ex. expense, but they should do much better than 1.59 (or the 1.60 I modeled) for 2012.

A few notes regarding the eps figure:

1. Assumes base case operational growth rates will act as trailing PEs. (So that pegs the stock price to a very conservative base case.)

2. EPS growth is fairly significant.

For me, the above is a baseline case. When factoring in higher revenue growth and increased GMs, there is far more operational income growth.

Management:

What makes this a baseline case is the fact the management team is no joke. They help build the true integration of online and brick-and-mortar store, whose operations are the most efficient in the world, the Apple Store. (And I am speaking of efficiency, not demand for product or product driven sales.)

Management's performance history and the above numbers, allow an investor to have the benefit of the doubt. (And the market indicated this today.)

Dividend:

Another added bonus, is the $0.80 dividend, giving a 2% yield even with the recent sizable stock appreciation.  I did not notice management suggest they will cut the dividend to fund the Cap. Ex. The Press Release did not mention it, so I will assume they will keep it.

Conclusion:


A base case model that suggests a stock price target of mid 60, and with a 2% yield to ride it out, seems like a nice situation to be in.

Of course, this is a show me story, but with a management that has already shown the street what it is capable of, the street will give it the benefit of the doubt, and will give the stock a richer multiple.

Technicals:


(I consciously put the technicals below the conclusion :) JCP is at a two and a half year high, so their maybe some sort of push back. But JCP is morphing into a new company so technicals prior to the last two day maybe irrelevant. I will use the last two days as the "new company" bottom (between high 30s and 40).

If JCP sees high 30s, or where ever the stock decides to consolidate, I will look to enter an initial position.

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