J.C. Penney may end up with $10.7 billion in net sales and 34.3% gross margins in 2019.
A 1% change in gross margins has the same impact as a 2.9% change in net sales on J.C. Penney’s EBITDA.
J.C. Penney probably needs 35% gross margins and a +8% sales improvement or 36% gross margins and a +5% sales improvement to get its EBITDA to where it needs.
A $100 million reduction in SG&A reduces the required sales improvement by around 2.6%.
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J.C. Penney’s (JCP) potential debt moves may buy it some more time or reduce its overall leverage. It still needs to deliver noticeable improvements in gross margins and sales in order to get its EBITDA up to a decent level though. The gross margin progress has been pretty good so far, but that is easier to achieve than sales improvements in the near-term, and there is also a limit to how much J.C. Penney can increase its gross margins.
It will be more challenging for JCP to increase its sales, but depending on what it can achieve with gross margins and cost reductions, the required sales growth ranges from a plausible low-single-digit number to an exceptionally hard-to-achieve high-single-digit number.
NYSE Listing Compliance
J.C. Penney’s stock quickly fell back under $1 after its surge earlier in September. This continues to keep it below the average closing price it needs (over a 30 consecutive trading days period) to maintain its NYSE listing.
However, J.C. Penney does have until its annual meeting (the 2019 meeting was on May 24) to gain approval for a reverse split. By that time, JCP will have already reported Q4 2019 earnings and discussed guidance for 2020. The company’s 2020 guidance probably will have a significant amount of influence on whether its share price can average $1+ over the required length of time before a reverse split is necessary.
2019 Outlook
Here’s a look at what J.C. Penney now appears to expect in terms of results for 2019. Net sales may end up around $10.7 billion, down around 8.3% from 2018. This includes -7% to -8% comps along with the effect of store closures.
Gross margins of 34.3% would be a 1.8% improvement from 2018, while a 0.5% increase in SG&A would put it at $3.615 billion for 2019. This would result in the company delivering around $455 million EBITDA for 2019.
| $ Millions | 2019 |
| Total Net Sales | $10,700 |
| Credit Income And Other | $400 |
| Total Revenues | $11,100 |
| Less: COGS | $7,030 |
| Less: SG&A | $3,615 |
| EBITDA | $455 |
Impact Of Sales And Gross Margins On EBITDA
A +5% increase in net sales from 2019 would result in JCP doing $11.235 billion in net sales. With gross margins remaining at 34.3%, the company would then end up with $639 million EBITDA.
| $ Millions | |
| Total Net Sales | $11,235 |
| Credit Income And Other | $400 |
| Total Revenues | $11,635 |
| Less: COGS | $7,381 |
| Less: SG&A | $3,615 |
| EBITDA | $639 |
A similar EBITDA result can be achieved by +0% net sales and an improvement of 1.7% to gross margins (bringing it from 34.3% to 36.0%). Thus we can see that a +5% change in net sales has the same effect on the projected EBITDA as a +1.7% change in gross margins. A 2.9% change in net sales has the same effect as a 1.0% change in gross margins.
| $ Millions | |
| Total Net Sales | $10,700 |
| Credit Income And Other | $400 |
| Total Revenues | $11,100 |
| Less: COGS | $6,848 |
| Less: SG&A | $3,615 |
| EBITDA | $637 |
Of those two items, gross margin improvement is probably easier to achieve quickly, as I believe that it would be easier for J.C. Penney to improve margins by 1% in 2020 than it would be to deliver +2.9% sales in that period.
However, gross margin improvement is also largely capped, as getting higher than 36% gross margins would be increasingly difficult (something like 38% gross margins appear to be essentially not achievable now). On the other hand, it is more possible (although not easy) to string together a series of years with +1%, +2% comps that add up to substantial gains over a long period of time.
Getting To $800+ Million EBITDA
To get to around $830 million EBITDA, JCP would need both +5% net sales from 2019 levels and 36% gross margins (a +1.7% improvement) if SG&A and credit income remained unchanged.
If J.C. Penney only got back to 35% gross margins (a +0.7% improvement from 2019 levels), then it would need +8% net sales growth to reach $830 million EBITDA. If it could get to 36.5% gross margins, then it would need +3.6% net sales growth.
J.C. Penney may be able to cut costs a bit more and reduce SG&A. If the company cut its SG&A by $100 million, then it would need 2.6% less sales growth in order to reach $830 million EBITDA. For example, at 35% gross margins, it would need +5.4% net sales growth, and at 36% gross margins, it would need +2.4% sales growth.
Conclusion
The gross margin progress has been good so far in 2019, bringing it up to around 34.3% potentially for the full-year. For a turnaround to succeed, J.C. Penney will need to get to around 35% to 36% gross margins at least. This is probably achievable, but the bigger challenge is to post positive sales growth in an environment where department stores have struggled to grow sales.
The amount of sales growth needed depends on what progress J.C. Penney can make with reducing SG&A and improving gross margins. Getting to 36% gross margins and cutting SG&A by $100 million puts its required sales growth at a relatively modest (such as +2.4%) level. Getting to 35% gross margins with no SG&A reductions makes the required sales growth a steep +8%.
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Disclosure: I am/we are short JCP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I have a small amount of JCP puts.
