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Walmart Needs to Buy J.C. Penney to Thrive

Customers already know they can walk into any Walmart store and get the best possible low prices. That's the differentiating factor it has over Target (TGT). Not to mention, Walmart management already has the small Neighborhood store concept in place. In the most recent quarter, revenue from that segment climbed 5% year over year.

In fact, since that concept was launched back in 2012, "Neighborhood" store growth has nearly doubled, while Walmart posted 46 straight quarters of comparable-store growth. But that's the only part of the operation that that's growing. Although management remains committed to growing the entire retail business, they've just guided to flat comparable-store sales in the U.S. 

J.C. Penney, by contrast, just posted 6.2% same-store sales growth and a narrower-than-expected loss, reflecting a 27% year-over-year improvement. And Penney's management has guided for improved gross margins and a mid-single-digit increase in same-store sales. These are metrics that Walmart, which guided for flat U.S. comps, could benefit from. But it goes beyond that. 

Target has shown that even bargain-hunting customers are willing to pay for some upscale products and brands. A J.C. Penney acquisition would neutralize Target's advantage, given that J.C. Penney has deals with Martha Stewart and other upscale brands. J.C. Penney's strong results were due to Ullman reinstating sales and other promotions. This falls right in line with the value proposition of Walmart stores.  

Walmart's first-quarter results weren't a disaster, given (among other things) the weather-related issues impacting retail. But they were not as good as they could have been -- as we see from J.C. Penney's results. And a combined company would be a major blow against rivals like Target.

Penney shares are currently trading at around $9.65. With a market cap of $3 billion and $5.6 billion in debt, the enterprise value comes to roughly $9 billion. This deal would cost Walmart $12 billion or $15 per share. Given Walmart's $23 billion operating cash flow and another $7 billion cash on the balance sheet, money will be no object.

Walmart only needs to ask how much its new image is worth.

At the time of publication, the author held no position in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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