Joshua Roy
11/27/2021
Cases in Financial Management
J.C. Penney Financial Analysis Project
I. Historical Financial Analysis
A. Financial Ratios- Liquidity
2010
2011
2012
Average
% Change
CAGR
Current Ratio
2.41
1.84
1.43
1.89
-41%
-16%
Quick Ratio
1.19
0.79
0.52
0.83
-56%
-24%
Cash Ratio
0.99
0.55
0.36
0.63
-64%
-28%
CashOperating
Expenses
0.43
0.24
0.17
0.28
-60%
-26%
Cash-to-sales
ratio
0.15
0.09
0.07
0.10
-53%
-22%
Assessing the liquidity ratios is important because it gauges the firm’s liquidity and
whether or not the firm has enough cash to continue its operations. Beginning with the current
ratio, the -41% percent change represents J.C. Penney’s dwindling of assets (particularly the cash
balance and the inventory) as well as the slight 13% decline in total liabilities. Looking at the 56% change in the quick ratio, it portrays that there is more than just inventory that is decreasing
at an alarming rate within the current assets. This is how one is led to the realization that the cash
balance is low as well. The declining cash balance can be observed in the -64% decrease in the
cash ratio and the mere fact that it has been decreasing by 28% annually. We can also see that the
cash balance is decreasing when compared to the operating expenses of the firm that has only
decreased by 12.4% in the 3 year period.
B. Financial Ratios- Asset Management
Days in AR
2010
2011
2012
Average
% Change
CAGR
N/A
N/A
N/A
N/A
N/A
N/A
Days in AP
89.46
83.52
104
92.33
16%
5%
Days in
Inventory
108.63
96.31
95.80
100.24
-12%
-4%
NFA
Turnover
3.40
3.34
2.43
3.05
-29%
-10.5%
Before the asset management ratios are examined, one key note is that there are no accounts
receivable in the current assets section of the balance sheet. Therefore, the days in Accounts
Receivable cannot be calculated. The overall purpose of asset management ratios is to determine
how effective the firm is managing their assets and whether there are areas of improvement. What
is quite interesting to observe is the 16% increase in accounts payable with a 5% CAGR, which
suggests that the firm is taking a longer time to pay back its current liabilities. The low cash balance
helps explain why J.C. Penney takes longer to pay back its creditors. As for days in inventory, the
-12% overall change reflects that they are taking less time to go through their inventory, which
indicates efficiency. However, the reality is that the firm has been decreasing its inventory by 10%
annually, which could also explain why they have been able to move through inventory at much
quicker rates. As for Net fixed asset turnover, the 29% overall decrease represents declining
revenues when the fixed assets hardly changed. This information leads one to believe that the
business is experiencing declining revenues and has ultimately led to lower cash balances, longer
times to pay current liabilities, and can possibly affect profitability.
C. Financial Ratios - Leverage
2010
2011
2012
Average
% Change
CAGR
Cash-Total
Debt
0.35
0.20
0.14
0.23
-60%
-26%
Cash-STD
0.99
0.55
0.36
0.63
-64%
-28%
Debt/Equity
1.39
1.85
2.08
1.77
50%
14%
Net
Debt/EBITDA
3.74
11.45
-7.41
2.59
-298%
N/A
Debt to Asset
0.58
0.65
0.68
0.64
17%
5%
Total Debt/
EBITDA
5.70
14.37
-8.62
3.82
-251%
N/A
Financial leverage ratios are important to glance over, because even the capital that is from
leverage can effectively be put to use. Moreover, it is also important to gauge the levels of leverage
the firm has taken on, for too much debt can have quite adverse effects. Beginning with the cashtotal debt ratio, the overall percentage change of -60% and a CAGR of -26% illustrates the same
idea brought forth in the liquidity ratios analysis, the rapid decrease in cash balances.The cash-std
portrays the same picture, the only difference being that the cash balance is compared to its current
liabilities. The cash to std also reflects J.C. Penney’s ability to pay back its near term liabilities
with the cash that it possesses.
Looking at the 2010 metric for cash-STD, we see that the firm was clearly able to pay its
debt with the cash it had. However, due to declining revenues and declining cash balance, the firm
is illiquid in 2012 as it cannot afford to pay its current liabilities with the cash balance that it has
currently. Another key figure to look at is the Net Debt/EBITDA we see a -298% change which
can be explained by the overall decrease in EBITDA as revenues decline. This is precisely why in
2011 net debt/EBITDA was an astronomical 11.45, the EBITDA was only $516 compared to 2010
EBITDA of $1334. The 17% increase in the Debt to Asset ratio reflects the 25% overall decrease
in total assets which stems from the declining cash balance and inventory. The Total debt to
EBITDA reveals almost the same exact thing as net debt/EBITDA except that the cash balances
arent subtracted from the total debt.
D.. Profitability Ratio
2010
2011
2012
Average
% Change
CAGR
Gross Margin
39%
36%
31%
35%
-21%
-7%
EBITDA
Margin
8%
3%
-6%
2%
-175%
N/A
EBIT Margin
5%
0%
-10%
-2%
-300%
N/A
Net Profit
Margin
2%
-1%
-8%
-2%
-500%
N/A
ROA
3%
-1%
-8%
-2%
-366%
N/A
ROE
7%
-4%
-31%
-9.3%
-543%
N/A
Assessing a firm’s profitability is paramount, as it determines whether investors will fund
expansion projects, debt offerings, and can overall influence a firms stock price if publicly traded
on an exchange. Starting with gross margins, the -21% overall decrease hints that the firm is
taking less profits due to declining revenues as observed on the income statement. What should
be noted carefully is the -175% change in EBITDA margin which reflects that J.C. Penney’s
EBITDA margins are in secular decline. This is primarily due to the weakening revenue
performance and indicates that the firm is facing profitability problems. This can be seen also in
the net profit margins as it decreased drastically due to declining revenues. It can be argued that
net profit margins are hurt because of increasing expenses, but the fact is that the firm does not
have the same ability to generate profits as it once did. Looking at ROA, what is quite interesting
is the -366% change over the period which clearly reflects that the firm is not achieving returns
against the assets it is deploying. As for ROE, the negative returns experienced in 2011 and 2012
are largely due to the decrease in equity (because of the decrease in cash balance, inventory, and
other assets).
2. FCFF Analysis
FCFF
2010
2011
2012
Average
% Change
CAGR
98
-127
-504
-177.66
-614%
N/A
Free cash flows are important because it allows a company to reward its shareholders in
the form of dividends, share buybacks, or reinvest the profits back into the business to generate
higher returns. The -614% change reflects the firms inability to generate cash due to declining
revenues. This is significant as it is quite clear that J.C. Penney’s does not have the cash flows
for organic growth, but may need to seek external financing.
II. Analysis Summary
The trend in the firm’s EPS implies that J.C. Penney is unprofitable due to declining
revenues as well negative cash flows. To understand the direction of the stock price depends on
the cash flows of the firm and we calculate the FCFF by adding net income + depreciation +/NWC - CAPEX. Given that the value of any asset is the present value of its future cash flows,
the value of the company cannot be computed due to the mere fact that the FCFF are negative.
This means that the firm does not have the ability to grow on its own, which could deter
investment sentiment. The stock price will fall in correlation with the FCFF and net income.
In terms of leverage, J.C. Penney does not rank high due to the fact that it cannot cover
its interest expense with its EBIT when most of J.C. Penney’s competitors have an
EBIT/Expense ratio of at least 5 except for sears . This is important as it can pose potential
liquidity problems and may be forced to take unfavorable loans to remain liquid or may have to
undergo a restructuring. As for Debt to EBIT, the only firm to do worse than J.C. Penney (2.3)
was Sears with a debt/EBIT ratio of (3.7) and is significant because Sears appears to be in
decline as well.
Weaknesses the firm possesses include negative cash flows, which pose a problem to the
firm’s operation, as they cannot issue dividend, reinvest in the business, or initiate buybacks for
its shareholders. Another weakness includes its cash to short term debt which illustrates the firm’s
problem with paying its short term debt with cash. Furthermore, the decreasing revenues place
tremendous strains on the margins of the business and have adverse effects on the cash balance of
the firm. Strengths the firm has include their efforts in reducing their debts by 13% that they had
during the 3 year period.