The Difference A Year Makes: Analyst Who Upgraded JC Penney A Year Ago 'Recalibrates' Expectations

A year after upgrading its rating on J C Penney Company Inc (NYSE: JCP), Baird recalibrated its estimates and valuation framework to better align its cautious stance on the department store sector.

A Recap Of Year-Earlier Rating Action And What Has Changed

Baird noted it upgraded shares of JC Penney last year after the pullback following the fiscal year first-quarter results of 2016, seeing a trading opportunity, as it executed on tangible growth initiatives, lowered costs and de-risked the balance sheet under a talented new management team.

"We remain encouraged by management's new direction for JCPenney and by success to-date on these initiatives," the firm said.

However, the firm noted top-line progress has been neutralized by intensified industry headwinds such as Amazon.com, Inc. (NASDAQ: AMZN) and off-price taking share, channel shift away from brick-and-mortar, and wallet-share-shift away from apparel. This, according to the firm, leaves earnings growth more dependent on aggressive SG&A cuts and asset sales and making any valuation premium to the sector difficult to justify.

Q1 Print

Analyst Mark Altschwager noted that JC Penney reported an unexpected profit for the first quarter, as SG&A cuts, gross margin upside and a large asset-sale gain more than offset a significant comp shortfall.

Like peers, the analyst noted comps were very weak in February before somewhat in March/April.

Guidance Incorporates Improvement From Normalized Trend

Baird views the unchanged guidance as suggesting improvement from a more normalized March/April trend line. The firm believes appliance tailwind would help comp. Along with higher asset sale gains, the firm expressed comfort with the unchanged adjusted-earnings per share guidance.

However, the firm feels apparel remains an ongoing headwind. The firm also said it sees some conservatism with the SG&A guidance, though believing that investors are almost exclusively focused on the top-line trajectory.

"While we continue to believe management has put JCP on a better path (diversifying product mix, trimming costs, de-risking balance sheet), core EBITDA growth looks more tenuous and valuation expansion is difficult to justify as industry headwinds intensify and earnings quality erodes (cost cuts, asset sales key drivers)," Baird said.

Downgrading Shares

As such, Baird downgraded shares of JC Penney to Neutral from Outperform, while it also reduced its price target to $5 from $8.

At the time of writing, JC Penney shares were down 4.29 percent at $4.35.

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