Why J.C.Penney's (JCP) Cash Position Looks Shaky: Sterne Agee

NEW YORK (TheStreet) -- Sterne Agee has placed J.C.Penney's (JCP) liquidity position under the microscope and found the embattled retailer's cash situation worrisome, so much so it has suspended its $3 price target.

The move comes nearly a week after institutional investors Hotchkis & Wiley, Dodge & Cox and Hayman Capital withdrew their positions in the retailer. Another, Evercore Trust, lowered its stake to 4.12% from 5.33%.

Sterne Agee's Charles Grom, Renato Basanta and John Parke said while they expect a sales turnaround, the company will likely run into cash concerns within a few quarters at the current pace of recovery.

"Our base case currently incorporates a 2% comp in FY14 and a potentially generous gross profit margin recovery to 35.5%, but this still results in ~$800 million in cash burn, including ~$1.26 billion burn through 3Q14's peak seasonal inventory build," the analysts wrote in the report.

"As a result, cash levels fall to very low sub $250 million levels in 3Q14, which we believe may be too tight for vendors' comfort."

Sterne Agee sees additional cash burn of around $1.2 billion through to the October-ending third quarter of fiscal 2015, despite around 3% comparable store growth. Such a rate of spending will likely require another capital raise, something the company should consider sooner than later.

"We estimate the company may need a $500-$750 million liquidity infusion given the current pace of sales/margin recovery," said the analysts.

The Plano, Texas-based retailer has continued to see comps down around 7% through 2013, albeit at a less drastic decline than 2012's 25.3% drop. The company's most recent third quarter marked the seventh consecutive period of negative EBITDA. In the period ended October last year, the company posted an EBITDA loss of $218 million and a per-share earnings loss of $1.85.

The analysts anticipate full-year cash burn of $2.7 billion, including a net loss of $1.8 billion and capital expenses of $990 million.

In order to maintain liquidity, the analysts note there are options, though limited. These include raising $500 million in debt through a term loan, selling peripheral assets such as its 240 acres of real estate, monetizing below-market leases, or issuing additional equity (a last resort measure).

The investment firm notes the route to positive free cash flow will occur once a "significant change in comp trajectory" takes hold.

"Sales per square foot likely need to be 25% + above trough 2013 levels with gross profit margins in the 36-37% range and SG&A per square foot growth of only ~3%-6% vs. 2013. Importantly, we still view this as achievable, but believe the pace of recovery needs to accelerate soon, particularly given the weather/macro headwinds we are seeing throughout retail," the analysts wrote.

Until the firm receives greater detail on J.C.Penney's recovery, Sterne Agee has suspended its $3 price target, but retains a "neutral" rating. The analysts anticipate a fourth-quarter and full-year net loss of 36 cents and $3.72 a share, respectively.

J.C.Penney is due to report its fourth quarter and fiscal 2014 after the bell on Wednesday, Feb. 26.

Analysts surveyed by Thomson Reuters anticipate a net loss of 82 cents a share on $3.86 billion in sales. For the full year, consensus is for a net loss of $6.11 a share on $11.93 billion in sales.

TheStreet Ratings team rates PENNEY (J C) CO as a Sell with a ratings score of D. The team has this to say about their recommendation:

"We rate PENNEY (J C) CO (JCP) a SELL. This is driven by several weaknesses, which we believe should have a greater impact than any strengths, and could make it more difficult for investors to achieve positive results compared to most of the stocks we cover. The company's weaknesses can be seen in multiple areas, such as its feeble growth in its earnings per share, deteriorating net income, generally high debt management risk, disappointing return on equity and poor profit margins."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • The debt-to-equity ratio is very high at 2.12 and currently higher than the industry average, implying increased risk associated with the management of debt levels within the company. Along with this, the company manages to maintain a quick ratio of 0.36, which clearly demonstrates the inability to cover short-term cash needs.
  • Return on equity has greatly decreased when compared to its ROE from the same quarter one year prior. This is a signal of major weakness within the corporation. Compared to other companies in the Multiline Retail industry and the overall market, PENNEY (J C) CO's return on equity significantly trails that of both the industry average and the S&P 500.
  • The gross profit margin for PENNEY (J C) CO is currently lower than what is desirable, coming in at 29.47%. It has decreased from the same quarter the previous year. Along with this, the net profit margin of -17.59% is significantly below that of the industry average.
  • Net operating cash flow has significantly decreased to -$737.00 million or 1502.17% when compared to the same quarter last year. In addition, when comparing to the industry average, the firm's growth rate is much lower.
  • PENNEY (J C) CO has experienced a steep decline in earnings per share in the most recent quarter in comparison to its performance from the same quarter a year ago. Earnings per share have declined over the last two years. We anticipate that this should continue in the coming year. During the past fiscal year, PENNEY (J C) CO reported poor results of -$4.49 versus -$0.73 in the prior year. For the next year, the market is expecting a contraction of 34.7% in earnings (-$6.05 versus -$4.49).

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