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TRANSCRIPT
Stock Pitch
Jared Ziment, Tommy Chen, DiAn Zhu, Derek Chait, Alec Mazzuckelli
September 21, 2014
2
Table of Contents
I. Investment Thesis
II. Macro/Industry Overview
III. Company Story
IV. Company Analysis
V. Appendix
I. Investment Thesis
4
J.C. Penney Co., Inc. (NYSE: JCP)
Recommendation: Buy Current Price: $10.23 1Y Price Target:$11.24 (+9.87%)
JCP’s market-share, turnaround strategy, and stabilizing margins present a favorable profile for a value opportunity
from a previously distressed company.
Strong Q2 results, three straight quarters of SSS growth and margin expansion support JCP’s turnaround story
Trading at a steep discount relative its peers on a sales and market share basis
Credit markets have been very accommodative; analyst day on 10/8 can be a driver of near turn price appreciation
CATALYSTS
RISKS
Weak consumer spending can severely affect top-line performance
Negative operating income and earnings likely over the medium term
Rising rates could make future refinancing harder and put a strain on liquidity
II. Macro / Industry Overview
6
Macroeconomic Conditions
Sources: US Census Bureau, the Federal Reserve
CONSUMER CREDIT LENDING (ex. Real-estate backed loans)
Personal consumption has potential to grow
Recent decline in personal expenditures is due to decreases in disposal and total income rather than the interest rate environment or changes in savings preferences
Other positive drivers
Consumer confidence index in August reached 92.4, the highest it has been since the last seven years (essentially since the 2008 recession)
Strengthening dollar against European and Asian currencies decreases the cost of production and imports for retailers doing business primarily in the United States
PERSONAL CONSUMPTION
-$ 6B
$ 0B
$ 6B
$ 12B
$ 18B
$ 24B
$ 30B
$ 36B
Apr May Jun Jul
Flow Credit Flows: Total (T), Non-Rev. (NR), Rev (R)
T MoM R MoM NR MoM
Steady growth in consumer loans
Credit outstanding since April has increased every month
Revolving loans (credit card spending) is experiencing accelerating growth
Strong uptick across the board in July
More affordable lending rates
Despite overall yields rising in the bond market, loans for consumer purchases have declined since Q2’13
Loans on interest bearing credit card accounts is 12.73% in Q2’14, down slightly from 12.76% in Q2’13
24-month personal loans has declined to 9.57% in Q2’14 from 10.34% in Q2’13
-$ 25 B
$ 8 B
$ 41 B
$ 74 B
$ 107 B
$ 140 B
-$ 20 B
$ 7 B
$ 34 B
$ 61 B
$ 88 B
$ 115 B
Apr May Jun Jul
Flow Chg. in Inc. (I), Dispos. Inc. (DI), Pers. Cons. Exp. (P)
I MoM DI MoM P MoM
7
Retail Trends
Sources: US Census Bureau, Bloomberg, SEC Filings
Recent retail sales trending up
Sales in the retail industry ticked up in August.
However, Department Store sales has trended sideways over the past year, but has made some progress.
Thanksgiving and Christmas sales were weak, although independence day sales were strong.
RETAIL AND FOOD SALES
Comparable department stores (NAICS 452111)
JCPenney is a mid-leverl player compared to other department stores. However, the firm faces strict competition from niche fast fashion retailers (H&M, Zara) and cost-leadership/generic retailers (Walmart, Target) – not included in the data.
JCPENNEY MARKET SHARE METRICS
$13.5B
$13.7B
$13.9B
$14.1B
$14.3B
Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug
Department Store Sales (Seasonally Adjusted) TTM
Macy's, 23.4%
Sears, 21.4% Kohl's,
16.3%
JC Penney, 11.0%
Nordstrom, 9.9%
Dillard's, 4.6%
Belk, 3.3% Saks, 2.7%
Department stores market share
Saks
Nordstrom
Belk
Dillard's
Macy's
JC Penney
Kohl's
Sears
109
271
299
302
836
1062
1160
1251
Ranked by number of stores
3.0%
3.6%
4.2%
4.8%
5.4%
6.0%
0.0%
0.2%
0.4%
0.6%
0.8%
May Jun Jul Aug
Retail and Food Store Sales RFS MoM RFS Core MoM RFS YoY
III. Company Story
9
Company Overview
Source: SEC Filings and S&P Capital IQ
Business consists of selling merchandise and services to consumers through our department stores and through our Internet website
1,062 stores in 49 states
Founded in 1902
Sells family apparel and footwear, accessories, fine and fashion jewelry, beauty products through Sephora
Offers services such as styling salon, optical, portrait photography and custom decorating
BUSINESS MODEL
MANAGEMENT
Myron E. Ullman, III (CEO)—2013 Previously CEO from 2004-2011 Previous Directeur General for Louis Vuitton Previous CEO of DFS Group and Macy’s
Edward Record (Executive VP, CFO)—2014 Former COO of Stage Stores 25 years of experience managing financial and
operational performance of retailers
D. Scott Laverty (Executive VP, CIO)—2013 Previous CIO of Borders Group Retail practice leader for HCL Axon Held senior consulting roles with IBM, PWC,
Deloitte, E&Y
REVENUE BREAKDOWN
2013 2012 2011
Women’s Apparel
24% 24% 23%
Home 22% 21% 20%
Women’s Accessories,
Including Sephora
11% 12% 16%
Children’s Apparel
11% 10% 9%
Family Footwear
9% 9% 8%
Fine Jewelry 7% 7% 7%
Services and Other
5% 5% 5%
JCP PERFORMANCE
0
10
20
30
40
50
1/4/2010 1/4/2011 1/4/2012 1/4/2013 1/4/2014
10
Source: SEC Filings, MS Notes, Earnings Call Notes
Debt to the Rescue
1Y and 5Y CDS Spreads (09-14)
Near Bankruptcy and Recovery Strategy
NEAR BANKRUPTCY
RECOVERY CATALYSTS—3 PILLARS
2011 Ullman replaced by former Apple executive Ron Johnson , wanted to rebrand image
No more coupons—went with lower prices and even prices but got rid of coupons
Segregated online and in-store inventory in 2011 (couldn’t find things online in stores and vice versa)
Renovated stores to appeal to a richer demographic, had stores under construction for a year
No emphasis on the online store—online sales tanked
Fired all top executives, thousands of middle managers, and got rid of sales commissions
Dividend suspended
Merchandise
New, upscale stores, restoration of key private brands
Continued partnerships with leading national brands
Coupons back—”buy it while it’s cheap” mentality
Omni-Channel Experience—Linking All Avenues
Realigned web and store inventory in 2013
Online store has taken off, +26% Q1 2014, +16.7% y/y
Save the sale by finding colors, sizes online, and ordering
Marketing
Targeted marketing campaigns like “back-to-school” working well
Source: Bloomberg
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
70.00%
0
1000
2000
3000
4000
5000
6000
2008 2009 2010 2011 2012 2013
Total Debt Debt/Equity
IV. Company Analysis
12
Operating Model Overview
Income Statement Snapshot
Cost Structure
Profitability Metrics
Fiscal Year
($ in mi l l ions) 2010A 2011A 2012A 2013A 2014 2015 2016 2017 2018
Net Sales $17,759.0 $17,260.0 $12,985.0 $11,859.0 $12,693.8 $13,430.0 $14,249.3 $15,118.5 $16,040.7
COGS $10,799.0 $11,042.0 8,919.0 $8,367.0 $8,170.6 8,460.9 8,834.5 9,373.4 9,945.2
Gross profit 6,960.0 6,218.0 4,066.0 3,492.0 4,523.2 4,969.1 5,414.7 5,745.0 6,095.5
SG&A $5,350.0 $5,109.0 4,506.0 $4,114.0 $4,186.3 4,429.1 4,699.2 4,985.9 5,290.0
Primary Pens ion Expense $221.0 $87.0 315.0 $100.0 ($16.1) (17.03) (18.07) (19.17) (20.34)
Supplemental Pens ion Plans $34.0 $34.0 38.0 $37.0 $26.2 27.71 29.40 31.19 33.09
D&A $511.0 $518.0 543.0 $601.0 $654.0 691.92 734.13 778.91 826.42
Real Estate $4.0 $21.0 (324.0) ($155.0) ($70.0) (74.06) (78.58) (83.37) (88.46)
Other $8.0 $451.0 298.0 $215.0 $27.0 28.6 30.3 32.2 34.1
Operating Expenses 6,128.0 6,220.0 5,376.0 4,912.0 4,807.3 5,086.2 5,396.4 5,725.6 6,074.9
Operating Income (Loss) 832.0 (2.0) (1,310.0) (1,420.0) (284.1) (117.1) 18.3 19.4 20.6
As a Percentage of Revenue 2010A 2011A 2012A 2013A 2014 2015 2016 2017 2018
COGS 60.81% 63.97% 68.69% 70.55% 63.00% 63.00% 62.00% 62.00% 62.00%
SG&A 30.13% 29.60% 34.70% 34.69% 32.98% 32.98% 32.98% 32.98% 32.98%
As a Percentage of Revenue 2010A 2011A 2012A 2013A 2014 2015 2016 2017 2018
Operating Margin 4.68% -0.01% -10.09% -11.97% -2.24% -0.87% 0.13% 0.13% 0.13%
Gross Margin 39.19% 36.03% 31.31% 29.45% 37.00% 37.00% 38.00% 38.00% 38.00%
Fundamental Perspective on Turnaround
2Q14 sales increased 5.1% to $2.80B (above estimated $2.78B)
Sales
Expenses
2Q14 SG&A dollars declined 6% ($62M) YoY
8.8% decrease in 2Q14 Operating Expenses YoY
Decline in Capex to $250M (from $500-$600M past 3 years)
Margins
Inventory
Annual Net Sales
2Q14 Gross Margin rose 36% (640 bps)
Improvement in sales trends, lower clearance markdowns, increasing penetration of private brands, expense controls
Normalizing to historical, pre-Johnson levels
Operating Margin improved to -2.5% from -14.8% in 2Q13
SG&A Quarterly
39.2
37.2
31.7
29.4
35
36.5
37.8 38.5
28
30
32
34
36
38
40
2 0 1 0 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5 2 0 1 6 2 0 1 7
Gross Margin
Total inventory was down 9.7% to $2.848 billion
Clean merchandise levels heading into 2H14
Sales/Inventory
11K
12K
13K
14K
15K
16K
17K
18K
F Y 2 0 1 0
F Y 2 0 1 1
F Y 2 0 1 2
F Y 2 0 1 3
E 2 0 1 4
E 2 0 1 5
E 2 0 1 6
E 2 0 1 7
E 2 0 1 8
E 2 0 1 9
1.2K
1.4K
1.6K
1.8K
2.0K
2.2K
2.4K
F Y 2 0 1 0 F Y 2 0 1 1
F Y 2 0 1 2
F Y 2 0 1 3
F Y 2 0 1 4
F Y 2 0 1 5
F Y 2 0 1 6
14
Cost Structure Normalization
JCP had the capital resources to avoid a bankruptcy filing and to preserve equity value
Ongoing signals of stabilization
Confidence the company can generate further EBITDA improvement for the balance of the year
Company will shrink store base and rationalize infrastructure
33 initial store closings $65 million of total cost savings
EBITDA accretion of $150M for 100 store closures
EBITDA Growth
“Turnaround” is on Track Further EBITDA Improvement
EBITDA Growth (Yearly)
-1000
-500
0
500
1000
1500
2000
2500
2 0 0 6 2 0 0 7 2 0 0 8 2 0 0 9 2 0 1 0 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5 2 0 1 6 2 0 1 7
Source: J.P. Morgan Research
15
Base / Bull / Bear Cases
Note: See appendix for scenario unlevered free cash flow breakdown
WACC 5.5x 6.5x 7.5x
13.00% $6,929 $7,826 $8,723
14.00% $6,646 $7,504 $8,363
15.00% $6,377 $7,199 $8,021
WACC 5.5x 6.5x 7.5x
13.00% $13.12 $16.72 $20.32
14.00% $11.99 $15.43 $18.87
15.00% $10.91 $14.20 $17.50
2014 2015 2016
y/y Sales grw. 7.70% 6.00% 6.50%
COGS/rev 63.00% 62.25% 61.50%
Op Margin -2.11% -0.55% 1.11%
Key Assumptions
BULL CASE
Enterprise Value
Terminal EBITDA Multiple
Price Per Share
Terminal EBITDA Multiple
WACC 5.5x 6.5x 7.5x
13.00% $5,426 $6,122 $6,819
14.00% $5,207 $5,873 $6,540
15.00% $4,999 $5,637 $6,275
WACC 5.5x 6.5x 7.5x
13.00% $6.92 $9.72 $12.51
14.00% $6.05 $8.72 $11.39
15.00% $5.21 $7.77 $10.33
2014 2015 2016
y/y Sales grw. 7.04% 6.00% 6.00%
COGS/rev 63.00% 63.00% 62.00%
Op Margin -2.24% -0.87% 0.13%
BASE CASE
Enterprise Value
Terminal EBITDA Multiple
Price Per Share
Terminal EBITDA Multiple
Key Assumptions
WACC 5.5x 6.5x 7.5x
13.00% $5,080 $5,691 $6,302
14.00% $4,878 $5,463 $6,048
15.00% $4,686 $5,246 $5,806
WACC 5.5x 6.5x 7.5x
13.00% $4.37 $6.82 $9.28
14.00% $3.56 $5.91 $8.25
15.00% $2.80 $5.04 $7.29
2014 2015 2016
y/y Sales grw. 3.04% 3.00% 2.90%
COGS/rev 64.00% 63.50% 63.00%
Op Margin -2.51% -1.34% -0.40%
BEAR CASE
Enterprise Value
Terminal EBITDA Multiple
Price Per Share
Terminal EBITDA Multiple
Assumptions
16
Fundamental Price Target
0
2
4
6
8
10
12
14
9/24/2013 9/24/2014 9/24/2015
+9.87% return
Case Price Probability Expected Value
Base $8.72 45.00% $3.92
Bull $18.87 35.00% $6.61
Bear $3.56 20.00% $0.71
Expected Price $11.24
Price Target Breakdown
Projected Trade Performance
17
Comparables Analysis
Sources: Thomson Reuters, SEC Filings
Undervalued but outperforming
Starting to outperform competitors.
JCP is extremely undervalued compared to its peers.
Price to market share shows people are forgetting that JCPenney remains a major player in the market and has an economic moat in terms of brand and value.
Price to sales confirms investors’ overly pessimistic attitudes towards JC Penney’s survival, without taking into the firm’s fundamentals.
Fiscal year 2015 PEG ratio of 0.03 is the lowest out of all its peers (peer median of 1.78).
Same store sales growth has steadily improved since 2013 and has actually outperformed that of competitors in 2014.
(16.60%)
(11.90%)
(4.80%)
2.00%
7.40% 6.00%
-20%
-15%
-10%
-5%
0%
5%
10%
Q1 2013 Q2 2013 Q3 2014 Q4 2013 Q1 2014 Q2 2014
Same Store Sales Growth JCP KSS M JWN
-63%
-27% -11% -2%
2% 39%
98% 101%
JCP
TGT KSS DDS
M
JWN
TJX ROST
Price to Market share (discount) vs. premium
0.3
0.5
0.7
0.7
0.8
1.0
1.5
1.5
JCP
TGT
KSS
DDS
M
JWN
TJX
ROST
0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6
Price to Sales comparisons
V. Appendix
19
Base Model FCF
Unlevered Free Cash Flow (UFCF) FY 2014 FY 2015 FY 2016 FY 2017 FY 2018 FY 2019
Net Income ($682.3) ($117.9) $18.4 $19.5 $20.7 $22.0
Interest Expense $393.2 $375.0 $380.0 $391.0 $384.8 $384.8
Taxes 2.89 0.00 0.00 0.00 0.00 0.00
D&A $654.0 $691.6 $733.8 $778.5 $826.0 $876.4
EBITDA $367.8 $948.7 $1,132.2 $1,189.1 $1,231.6 $1,283.2
EBIT ($286.2) $257.1 $398.4 $410.5 $405.5 $406.8
( – ) Taxes 100.2 (90.0) (139.4) (143.7) (141.9) (142.4)
Unlevered net income (186.0) 167.1 259.0 266.9 263.6 264.4
( + ) Depreciation 654.0 691.6 733.8 778.5 826.0 876.4
( – ) Capital expenditures (295.6) (312.6) (331.7) (351.9) (373.4) (396.1)
( – ) Change in working capital 82.9 (109.5) (122.8) (130.3) (138.3) (146.7)
( – ) Change in deferred taxes (172.8) (29.2) (32.8) (34.8) (36.9) (39.1)
Unlevered free cash flow $82.6 $407.5 $505.5 $528.4 $541.1 $558.9
20
Bull Model FCF
Unlevered Free Cash Flow (UFCF) FY 2014 FY 2015 FY 2016 FY 2017 FY 2018 FY 2019
Net Income ($669.9) ($74.7) $160.6 $325.8 $347.1 $369.8
Interest Expense $395.4 $375.0 $380.0 $391.0 $385.4 $385.4
Taxes $2.9 0.00 0.00 0.00 0.00 0.00
D&A $657.9 $697.4 $742.7 $791.2 $842.9 $897.9
EBITDA $386.3 $997.7 $1,283.3 $1,508.0 $1,575.3 $1,653.0
EBIT ($271.6) $300.3 $540.6 $716.8 $732.5 $755.1
( – ) Taxes 95.1 (105.1) (189.2) (250.9) (256.4) (264.3)
Unlevered net income (176.5) 195.2 351.4 465.9 476.1 490.8
( + ) Depreciation 657.9 697.4 742.7 791.2 842.9 897.9
( – ) Capital expenditures (297.3) (315.1) (335.6) (357.5) (380.9) (405.8)
( – ) Change in working capital 71.2 (114.9) (132.0) (141.2) (150.4) (160.3)
( – ) Change in deferred taxes (175.9) (30.7) (35.2) (37.7) (40.1) (42.7)
Unlevered free cash flow $79.4 $431.8 $591.3 $720.7 $747.5 $780.0
21
Bear Model FCF
Unlevered Free Cash Flow (UFCF) FY 2014 FY 2015 FY 2016 FY 2017 FY 2018 FY 2019
Net Income ($693.1) ($170.2) ($52.6) $13.0 $13.4 $13.8
Interest Expense $381.0 $375.0 $380.0 $391.0 $381.7 $381.7
Taxes $2.9 0.00 0.00 0.00 0.00 0.00
D&A $632.5 $651.5 $670.4 $689.8 $709.8 $730.4
EBITDA $323.2 $856.3 $997.8 $1,093.8 $1,105.0 $1,125.9
EBIT ($309.3) $204.8 $327.4 $404.0 $395.1 $395.5
( – ) Taxes 108.2 (71.7) (114.6) (141.4) (138.3) (138.4)
Unlevered net income (201.0) 133.1 212.8 262.6 256.8 257.1
( + ) Depreciation 632.5 651.5 670.4 689.8 709.8 730.4
( – ) Capital expenditures (285.3) (293.8) (302.3) (311.1) (320.1) (329.4)
( – ) Change in working capital 154.1 (55.0) (54.8) (56.3) (58.0) (59.7)
( – ) Change in deferred taxes (153.8) (14.7) (14.6) (15.0) (15.5) (15.9)
Unlevered free cash flow $146.5 $421.1 $511.5 $570.0 $573.1 $582.5