Wednesday, August 29, 2012

Stocks DD Cites: Ackman's continued pitch on JC Penney worth listening

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The JCP bears’ principal argument rests on additional dramatic declines in sales contributing to balance sheet deterioration at the company. In fact, JCP’s balance sheet is equipped to handle even a large decline in sales for several reasons. Unlike most other retailers for which rent is an enormous fixed cost, JCP’s real estate cost is very low because it owns 50% of its stores and leases the balance at low single-digit rents. The company also benefits from long-term, low-cost debt with limited expirations over the next several years, more than $800 million of cash at the last quarterly report, $1.5 billion of undrawn revolver capacity, and more than $600 million of non-core assets that it can sell. 

Retailing is a cash-flow seasonal business. Certain bearish investors have annualized the first quarter’s negative cash flow in modeling the company’s future cash flows. As with other retailers, most of JCP’s cash generation will occur in the fourth quarter of the year. At its last analyst presentation, the company estimated that it will generate approximately one billion of operating cash flow in 2012 which will be sufficient to fund its $800 million in capital expenditures for new shop development and other needs. Even if the company’s estimates prove optimistic, JCP’s significant liquidity and financial resources should enable it to weather all but the most catastrophic storms.

The company has executed successfully on $900 million of annual cost savings that will drop to the bottom line beginning over the next several quarters. Starting next year, the company’s quarterly sales will be compared with the first quarter’s 18.9% decline, and will benefit by the launch of several new branded shops each month and further improvements to the pricing message and strategy. In light of the large reduction in operating costs, even a modest increase in sales in 2013 should generate large cash flows and profits for shareholders. We look forward to the continued transformation.
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      Also, what was most interesting was the 25% sales increase reported in the newly modeled Levis store.

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