August 16, 2016

Going long on JC Penny shares

I initiated a small starter position against my short exposure in retail in J.C. Penney (JCP)this morning, and I plan to buy more on weakness. JCP reported a solid quarter in a weak retail industry setting. Sales increased slightly (+$43 million) or +2.2% on a straight compare in units, so its market share grew modestly.

Earnings before interest taxes and depreciation (EBITD) increased by $80 million as gross margins improved and expenses were well under control. Interest expenses declined by $1 million as inventories remained under control and debt was reduced in a period where it normally increases seasonally.

While interest coverage is only 2.2 times, it is rising steadily and predictably.

The shares moved up briskly along with its retail peers on Thursday, so I plan to build on weakness.

Guidance was not increased ($1 billion this year, $1.2 billion next year in EBITD). Shares closed Friday up over 6% to $10.55.

On a short-term basis, the company is hosting an analyst day next week in Dallas, and I suspect it may strike a more optimistic tone. Valuation is reasonable. Debt is $4.2 billion compared to equity at $3 billion; enterprise value totals $7.2 billion.

Twelve-month trailing EBITD is $888 million. The 12-month multiple is 8.2 times. While this is an elevated multiplier, it's acceptable as EBITD is rising, the chain's competitive position is improving, and the company is moving into a free cash flow position.

Residual bearishness remains in this name, manifested by nearly 30% on the shares short. The short story is growing long in the tooth.

I expect the shares to climb out of its trading range and I have a year-end target of $12 to $13. (While I am comfortable with the reward/risk ratio, it's not out of balance enough to place the stock on my Best Ideas list.)

I am currently limiting my buy order to $10 per share.

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