JC Penney: Good Exit Point

JC Penney Co. (NYSE:JCP) reported second-quarter EPS of $0.52, which was $0.02 ahead of consensus. For the third quarter, the management expects to earn $0.70-$0.75 per share compared to the previous consensus of $0.76. Despite the government’s $600 stimulus checks, the company still reported poor results in the second quarter results with sales down 2.5% and earnings down 33.7%.

Even so, the shares are up about 40 percent off their July lows. We think this rally should be sold. We continue to believe the macro conditions that have negatively affected consumer discretionary spending are not improving. That will weigh on JC Penney’s results in the second half of the year. We also believe that consensus estimates are too high and will need to come down. As a result, we are downgrading the stock from Hold to Sell.

The shares currently trade at 12.8x our fiscal 2008 EPS estimate and 12.5x our fiscal 2009 EPS estimate. We think the stock is overvalued, given the negative headwinds facing the consumer (housing, tightening credit standards, and higher energy and food prices).

The company was able to beat second-quarter estimates, but the management’s third quarter guidance was below consensus estimates. We believe that consensus estimates are still too high for the second half of the year and will need to come down. Our target price is 10x our fiscal 2009 EPS estimate or $32.

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