Investors seem enthusiastic about the news that Home Depot (HD) executive Marvin Ellison will take over as chief executive of J.C.Penney (JCP) next year, succeeding the retailer's current CEO Myron E. Ullman III. The shares were up nearly 3% at noon on Monday.
However, UBS analysts Michael Binetti, Steven Strycula, and K.C. Stumbaugh don't see much cause for celebration. They downgraded the stock to Sell today, cutting their price target in half, to $5, and write that while Ellison is "credible hire," he isn't the solution to J.C.Penney's ongoing structural issues.
First, the downgrade. Binetti and his team believe that the company's target of $1.2 billion in EBITDA by 2017 is "overly optimistic" given slow growth in the department store industry and the lack of a clear roadmap for taking share from rivals like Macy's (M) and Kohl's (KSS). This skepticism comes as same-store sales trends are decelerating.
More highlights from the note:
From our prior 2017 EBITDA forecast of $800m, we’re adding +$400m to reflect JCP’s plan to hold SG&A dollars flat through ’17. That said, we are reducing our ’15E-’17E SSS estimates to +4% in each year (from +5% previously, and below JCP’s guidance for a +5.4% 3-yr SSS CAGR)—bringing our ’17E EBITDA to ~$1B (below JCP’s $1.2B target). While the net effect raises our EBITDA from $800m to $1B, the quality of this increase is low based on lower SSS and little detail on how JCP will contain SG&A.
We’re also lowering our price target & rating to reflect lower SSS estimates & JCP’s elevated cash flow risk vs peers (high debt) if sales continue to miss JCP’s plan. With the potential EBITDA scenarios for JCP becoming clearer, we think it’s time for valuation to normalize back to in line with (or at the low end of) the historical peer average (5x-6x EBITDA). Even using JCP’s 3-yr targets (which we find too bullish), the 1-yr forward stock value would be ~$7/share (5.5x, mid-pt of 5-6x historical range, 10% disc. rate)—near today’s price.
There are other issues as well. Binetti and team believe that negative traffic trends will force J.C.Penney to revert to deep discounts to attract customers, while the landscape has only become more crowded, with nearly 900 new stores from its various competitors opening in the past four years. With no significant cost restructuring or store closure program on the horizon, they are skeptical of the company's selling, general and administrative targets, and they write that there will be "significant negative cash flow implications if JCP is unable to achieve its $14.5B 2017 revenue guidance."
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The analysts downgraded the stock independent of Ellison's appointment, but they don't see that making much of a difference to their thesis. They write that a new CEO—especially one without experience in the softline space—won't be able to do much to amend the many structural problems J.C. Penney faces:
We’re surprised at the timing of the CEO hire given JCP just last week rolled out a 3-yr strategy that we don’t think it will be able to achieve. An effective store operator helps, but JCP needs merchant/product talent to drive traffic. While bringing in a credible new CEO has some benefits, JCP’s customers are leaving the store (traffic is negative). Competition for cheap apparel has increased significantly (TJX/ROST/H&M/ KSS/M//TGT/Forever 21 have added 880 new US stores since ’10) and JCP’s product is largely undifferentiated. Cash flow risk is high (w/high debt vs peers)—limiting JCP’s ability to boost advertising or renovate stores at the same pace as peers.
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