Last weekend, Barron's quoted Hodges Capital portfolio manager Chris Terry as saying that J.C. Penney(NYSE: JCP) stock could rise 50%-100% in the next three years -- moving as high as $20. While J.C. Penney stock rallied on Monday morning, it has given up all of those gains in the past few days -- and then some.
J.C. Penney's comeback is gaining traction. Image source: The Motley Fool.
Clearly, most investors are still skeptical of J.C. Penney's turnaround progress. However, if the company can continue to hold down expenses while posting steady 3%-5% comp sales growth over the next few years, J.C. Penney stock could certainly double.
J.C. Penney is regaining share
Just a few years ago, J.C. Penney was in a tailspin and looked like it would never recover. Sales plunged from $17.3 billion in 2011 to $11.9 billion in 2013.
However, since then, J.C. Penney has managed to post steady comparable store sales growth in a tough retail environment. This performance allowed it to boost sales to $12.6 billion by 2015, despite reducing its store count from 1,094 to 1,021 over the past two years.
Meanwhile, Sears Holdings(NASDAQ: SHLD) -- a key rival in the affordable-department-store space -- has continued its inexorable decline. Domestic comparable-store sales have been falling at Sears for more than a decade, punctuated by a 9.2% drop last year.
Sears has closed hundreds of stores in recent years. Image source: The Motley Fool.
For years, Sears has been steadily shrinking its store base to cut costs. This trend will continue for the foreseeable future, as Sears' plan for returning to profitability relies on closing and downsizing even more stores.
While Sears is the most vivid example of the difficulties facing major retailers recently, most department-store chains -- even the strongest ones -- reported stagnant or declining comp sales in 2015. J.C. Penney was one of the few exceptions.
Maintaining sales momentum
Obviously, J.C. Penney will need to keep growing its sales and gaining market share for its turnaround to succeed. It has several promising initiatives in place to drive sales growth in the next few years, which I have described previously. These include rolling out new Sephora boutiques, remodeling the "center core" sections in many stores, rebranding its salons, and testing appliance sales in certain markets.
J.C. Penney is also focusing on serving its core customer base better, whereas a few years ago it was trying to transform itself to attract a completely different customer. For example, it recently announced the launch of a new plus-size fashion brand for millennial women called Boutique+.
In addition to these "self-help" efforts to drive sales growth, J.C. Penney should also benefit from the retrenchment of competing department-store chains over the next few years. As rivals such as Sears continue to close or downsize stores, J.C. Penney is well positioned to siphon off some of their customers.
J.C. Penney doesn't need massive sales gains to drive strong earnings growth. If the company grows sales just 3.5% annually through 2020 while keeping operating expenses flat, its annual operating income could rise by $850 million.
Debt will become a lot more manageable
Many skeptics -- while admitting that J.C. Penney's sales trajectory has improved -- point to its debt load as a big anchor that will drag J.C. Penney stock down. A couple of years ago, I would have agreed with that assessment.
However, J.C. Penney has already started to get its debt under control. Just in the past two years, J.C. Penney has reduced its total debt from $5.6 billion to $4.8 billion, as it has produced modestly positive free cash flow and the company's improving financial performance has allowed it to carry less cash.
A few months ago, J.C. Penney CFO Ed Record stated that the company plans to reduce its debt load by another $400 million to $500 million this year, assuming it can sell and lease back its headquarters.
J.C. Penney will be able to continue paying down debt in future years using its free cash flow. The company expects to surpass last year's $131 million in free cash flow in 2016, and if its sales growth initiatives pay off, free cash flow should continue to grow steadily in the years ahead.
By the end of 2019, J.C. Penney may be able to reduce its debt to around $3 billion to $3.5 billion while lowering the interest rate on much of its remaining debt. Thus, interest expense savings represents another big lever for earnings growth. At the same time, the lower debt load will make J.C. Penney stock less risky, which should boost its earnings multiple.
If J.C. Penney can increase its operating income by $850 million and cut its debt load by about $1.5 billion over the next three or four years, there's a very good chance its stock will double. To reach those goals, it just needs to maintain its recent sales momentum while keeping costs in check.
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