more about JCP

I’ve been thinking about Bill Ackman and JCP over the past few days, enough to have looked at the most recent financials for the company.  Why am I writing about this again?   You can usually a learn a lot from a situation where the wheels are starting to come off, and JCP’s 4Q12 financials give a good example of why the cash flow statement is an important document to study.

I haven’t (yet, at least, and I may never) done a real analysis and come up with an investment conclusion.  But I do have a reasonable hypothesis about what’s going on.  By way of its stores’ physical locations, JCP controls a lot of real estate, either through long-term lease or by owning it.  Given Mr. Ackman’s interest in real estate and his prior experience with Target, I imagine his plan has been to ultimately separate JCP into two parts, a real estate entity and a department store and thereby hopefully getting a much higher stock market valuation for each.  I’m sure he also saw some low-hanging operational fruit:  costs were too high, inventories were bloated, some non-essential assets could be sold.  Addressing these issues could raise a ton of cash.

In addition, the real estate value is connected in a strong way to the viability and profitability of JCP stores.  If the department store business is booming, the value of the real estate–in the sense of the ability to raise the rent–rises (and vice versa).  So a Ron Johnson-led makeover of JCP could have a big positive effect on both the value of the stores and the real estate on which they lie.

So much for the concept.  Where does JCP stand now?

Let’s take a look at the 4Q12 earnings report presentation:

recurring items

–during 2012, JCP cut SG&A (Sales, General & Administrative) expense by $603 million, even after  boosting marketing by $25 million and IT spending by $25 million.  That’s tremendous.

–at the same time, 2012’s same store sales comparisons fell by 25.2%.  Worse, comparisons deteriorated steadily as the year progressed, reaching -31.7% during 4Q12.  The number pf people going into JCP stores was off by 13% for the year, with, again, the low point of -17% happening during 4Q.  Conversion, meaning the percentage of people visiting the store who actually bought something, showed the same pattern:  -9% for the year, -10% for 4Q12.  To state the obvious, something went horribly wrong with department store operations.

–the cash flow statement (I’ve rearranged the order of the items JCP lists to give what I think is a more coherent story)…

Under GAAP (the accounting conventions used for financial reporting), JCP lost $985 million during 2012.

GAAP allows a company to reduce the reported loss by the extent it can shelter future profits from income tax (called deferred tax).  For JCP, this was $350 million.  Correcting for this, the pre-possible-future-tax-benefit loss was $1.335 billion.

Part of any company’s expenses are provisions for wear and tear on plant and equipment (the buildings, display counters and other fixtures).  This is called depreciation and isn’t cash out the door.  For JCP, this was $543 million.  Adding that back in gives a sense of whether the company took in money or had an outflow during the year.  In JCP’s case, the “cash flow” number is a loss of $792 million.

one-time items

JCP sold non-core assets during the year.  It wrote down others and took an employee benefit charge.  The gain on the sale and the charges pretty much offset one another, although the asset sales brought in $526 million in cash.

The company got rid of a lot of excess inventory, generating $575 million in cash in the process.  It also got better payment terms from suppliers that saved it, at least temporarily, from paying $140 million for merchandise.  Together, the two working capital actions generated $710 million in cash.  

The net of all this–and a couple of items I didn’t mention–is that operations pretty much broke even.

What’s important to note is that breakeven happened, in my view, only because the inventory and payables adjustments generated $710 million.  I doubt this can happen again in 2013.

investing/financing

JCP spent $810 million last year overhauling its stores and repaid $250 million in debt.  That’s an outflow of $1.060 billion.  It got $526 million in from asset sales.  There were a couple of other small items, leading to a net outflow of $$567 million from investing/financing.

the bottom line

For full-year 2012, JCP had a net outflow of cash of $577 million.  What jumps out at me, though, is that the figure is only this low because of asset sales and working capital adjustments totaling $1.236 billion.  Without them, the outflow is $1.8 billion+.

Of course, JCP would never have embarked on its aggressive store remake had it not figured the $1.236 billion would be available.  What it didn’t anticipate was the drain on cash from the collapse in sales.

where to from here?

In February, JCP announced it has negotiated an increase in its bank credit line to $1.85 billion.  I read this as as much a psychological event as a financial one–to reinforce the idea that JCP has plenty of money to carry out its transformation.

In the 4Q12 earnings call transcript I read, I was struck by the fact that many analysts wished the company good luck after they asked questions.  I can’t remember ever having seen this before.  Putting on my fortune-teller’s hat, I think analysts believe JCP is on the right track but are not yet 100% convinced that this story will have a happy ending.

As far as cash goes, the company now has about $800 million on the balance sheet.  It says it has non-core assets worth several hundred million dollars that it can sell.  And it has it bank credit line.  Absent a repeat of the horrible operating performance of 2012, that should be enough.

On the other hand, Vornado Realty Trust, an ally of Pershing Square Capital, recently sold 40% of its holding in JCP–hardly an act that inspires confidence.

For me, at this point JCP is an interesting case study and nothing more.  I have no special edge here.  I have no idea whether sales will begin to rebound quickly–in which case JCP shares would skyrocket–or not. And I don’t need to have an opinion.   So I’ll just watch from the sidelines.

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