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Simon Property Group and Brookfield Property REIT are reportedly interested in buying the bankrupt department store chain to prevent the disappearance of a key anchor tenant.

Last month, J.C. Penney (NYSE:JCP) filed for bankruptcy protection, following a decade of turmoil marked by several management changes, falling sales, and plunging profitability. While J.C. Penney was able to line up $450 million of debtor-in-possession financing — half of which is available immediately — that will only keep the iconic department store chain afloat temporarily. If the company fails to produce a viable go-forward business plan in the weeks ahead, the restructuring could be converted into a complete liquidation as soon as mid-July.

J.C. Penney’s biggest landlords might have something to say about that, though. Leading mall REITs Simon Property Group (NYSE:SPG) and Brookfield Property REIT (NASDAQ:BPYU) — which also trades as Brookfield Property Partners (NASDAQ:BPY) — are considering teaming up with private-equity firm Sycamore Partners to rescue the ailing retailer, according to Reuters.

A new restructuring plan

When J.C. Penney filed for bankruptcy protection last month, it put forward a plan to quickly reduce its debt so that it could emerge from the restructuring process within a few months. Management’s plan for exiting bankruptcy hinges on spinning off much of J.C. Penney’s real estate as a new REIT. A separate company would operate the core retail business.

While there could be some advantages to this structure, it’s far from a slam dunk. Given the turmoil upending the retail industry, the REIT might struggle to find new tenants for any properties vacated by the J.C. Penney retail business. Redevelopment work is also very expensive. Meanwhile, the retail business would be saddled with higher costs, as it would have to pay rent to the new REIT.

If this business plan isn’t attractive enough to creditors and potential investors, an acquisition would be J.C. Penney’s only hope of survival. Amazon.com has apparently been sniffing around the company and considering a bankruptcy bid. However, I’m skeptical that anything will come of this. There’s plenty of retail real estate available today, and lots more is likely to come on the market over the next year or two due to the post-COVID-19 retail shakeout. If Amazon wants to try operating large-format stores, it would make more sense to build them from scratch.

A more plausible acquisition scenario emerged last week. Private-equity firm Sycamore Partners, which owns multiple retail brands (including regional department-store chain Belk) is interested in buying J.C. Penney, if negotiations between the retailer and its creditors fall through. One option under consideration is a joint bid between Sycamore and top mall owners Simon and Brookfield. This could be J.C. Penney’s best hope for survival.

Why Simon and Brookfield might intervene

The conventional wisdom is that Simon Property Group and Brookfield Property REIT would be perfectly happy for J.C. Penney to disappear. They own lots of valuable, top-tier malls where they charge high rents. However, as a long-standing anchor tenant, J.C. Penney pays very little rent (and no rent, in the case of stores that it owns outright). Thus, store closures would give Simon and Brookfield opportunities to redevelop those locations for higher-paying tenants.

SIMON AND BROOKFIELD OWN SOME OF THE BEST MALLS IN THE U.S. IMAGE SOURCE: SIMON PROPERTY GROUP.

There’s some truth to this perspective. That said, it could be difficult to find replacement tenants in the current environment. Many mall owners have responded to changing retail trends by redeveloping former department store buildings for fitness, entertainment, and dining uses. If anything, those “experiential” tenants have been hit even harder by the COVID-19 pandemic than retailers.

Furthermore, Simon Property Group has 63 J.C. Penney stores in its portfolio. Brookfield has even more exposure, with 73 stores. Many of those stores are in malls that are average or above-average — but not the cream of the crop. There would be limited value in recapturing space from J.C. Penney in those malls. Moreover, having anchor vacancies for an extended period could hurt those properties’ long-term prospects.

Finally, redeveloping a department store often costs $20 million or more. Considering the number of locations involved, the total redevelopment cost would be substantial. By buying J.C. Penney and preventing a liquidation, Simon and Brookfield would significantly reduce the near-term capex burden they face. (Some stores will close even if J.C. Penney stays in business; the retailer recently announced a first round of 154 store closures.)

Importantly, there’s precedent for Simon and Brookfield to buy retailers out of bankruptcy to keep them alive. Just a few months ago, the two teamed up with Authentic Brands Group to buy Forever 21. And in 2016, Simon, General Growth Properties (which was later acquired by Brookfield), and Authentic Brands Group saved Aeropostale from liquidation.

The next month or two will be crucial

While Simon and Brookfield have a vested interest in avoiding an immediate liquidation of J.C. Penney, they also don’t want to lose a lot of money in any potential deal. That means they aren’t likely to make a bid unless there are clear signs that the retailer’s business is stabilizing.

So far, fewer than 500 of J.C. Penney’s 846 stores have reopened. Sales in the first batch of stores to reopen are down about 33% year over year. That’s not too bad considering that many people are still reluctant to venture out, but J.C. Penney was already struggling with weak customer traffic before the pandemic: It can’t afford any further declines.

If J.C. Penney can reopen the rest of its stores later this month and achieve sequential improvement in sales trends over the next several weeks, Simon and Brookfield might get serious about putting in a bid for the company. By contrast, if traffic remains depressed for a longer period of time, liquidation could become inevitable.

Author: Adam Levine-Weinberg

Source: Fool: 2 Top Mall REITs Might Buy J.C. Penney Out of Bankruptcy

The Oracle of Omaha hasn’t done much buying in 2020, despite a 35% stock-market plunge earlier this year. Warren Buffett did the same thing in similar circumstances more than three decades ago.

Just two months ago, the stock market was in free fall due to fear about the impact of the COVID-19 pandemic. The S&P 500 index plunged 35% between mid-February and late March. That represented the deepest bear market since the Great Recession.

The massive sell-off in stocks led many investors to wonder whether famed investor Warren Buffett would capitalize on this opportunity to make some big stock purchases — or even acquire entire companies. After all, Berkshire Hathaway’s (NYSE:BRK.A) (NYSE:BRK.B) insurance subsidiaries ended 2019 with a whopping $125 billion of cash and U.S. Treasuries available to make investments.

Instead, at Berkshire’s annual meeting earlier this month, Warren Buffett revealed that the conglomerate had been a net seller of stocks year to date. Berkshire Hathaway only made minor stock purchases — at least by Berkshire standards — and they were more than offset by Buffett’s decision to bail out of airline stocks.

Yet while many were shocked by this inactivity, the events of the past few months were hardly unprecedented. In fact, the past year looks like a repeat of 1987 for Warren Buffett and Berkshire Hathaway.

Looking for elephants

As Berkshire Hathaway’s cash pile has grown in recent years, Warren Buffett has talked repeatedly about looking for “elephant-sized” acquisitions. However, he has been waiting for attractive companies to become available at reasonable prices. As usual, Buffett has been careful not to get greedy by buying “cheap” stocks with weak business fundamentals.

Buffett reiterated this point a little over a year ago in his annual shareholder letter:

In the years ahead, we hope to move much of our excess liquidity into businesses that Berkshire will permanently own. The immediate prospects for that, however, are not good: Prices are sky-high for businesses possessing decent long-term prospects.

That disappointing reality means that 2019 will likely see us again expanding our holdings of marketable equities. We continue, nevertheless, to hope for an elephant-sized acquisition.

Indeed, Berkshire Hathaway’s cash pile increased significantly last year. Aside from the lack of attractive acquisition candidates, Buffett also struggled to find reasonably priced stocks to buy. And even though the stock market’s plunge earlier this year was deep and traumatizing, it didn’t change this dynamic.

Another 1987

In more than half a century leading Berkshire Hathaway, Warren Buffett has experienced all sorts of market conditions. But what’s transpired recently was hardly unique.

In his 1986 shareholder letter (published in early 1987), Buffett wrote, “[W]e currently find no equities that come close to meeting our tests.” He observed that “euphoria” on Wall Street had driven stock prices up to levels that didn’t correspond to the companies’ underlying business prospects. As a result, during 1986, Buffett put most of Berkshire Hathaway’s excess cash into tax-exempt bonds, seeing them as the least bad alternative.

Just months later, Wall Street’s euphoria finally evaporated in dramatic fashion. Stocks began to slide in the first half of October 1987. And on Black Monday — Oct. 19, 1987 — the stock market plunged more than 20% in a single day. Despite that record-setting drop, Buffett didn’t buy much stock during 1987. As he described in his annual shareholder letter:

At Berkshire, we have found little to do in stocks during the past few years. During the break in October, a few stocks fell to prices that interested us, but we were unable to make meaningful purchases before they rebounded. At yearend 1987 we had no major common stock investments (that is, over $50 million) other than those we consider permanent or arbitrage holdings.

At first glance, the lack of action might seem surprising. But as Buffett noted, the stock market actually rose 2% in 1987. There was a massive rally, followed by a deep plunge, followed by a modest rebound. Given that the Oracle of Omaha didn’t see any compelling opportunities in 1986, it’s not surprising that he couldn’t find much worth buying in 1987.

S&P 500 1987 PERFORMANCE, DATA BY YCHARTS.

The stock market’s action over the past year has been eerily similar to what occurred in 1987. As Buffett put it three decades ago, there has been “much excitement but little net movement” — the market experienced a big rally, a massive drop, and then a rapid recovery. The net result is that the S&P 500 has risen a little more than 1% in the past 12 months.

S&P 500 PERFORMANCE, DATA BY YCHARTS.

Just as in 1987, stocks were only cheap for an instant during this year’s bear market. Even then, they weren’t that cheap. In a clear parallel to 1987, the market didn’t go low enough for long enough to enable Buffett to make big stock purchases, let alone acquire a large, high-quality business at an attractive price. By late April, stock prices were back to the year-ago levels at which Buffett saw few (if any) compelling opportunities in the stock market.

No reason for Berkshire investors to be demoralized

Naturally, many Berkshire Hathaway investors were disappointed that Warren Buffett didn’t find anything to buy during this year’s market crash. After all, it seemed to many that this was the moment they had been waiting for, when Buffett would finally move Berkshire’s massive pile of cash and low-yielding Treasuries into companies that could deliver fantastic long-term returns.

Shareholders shouldn’t be too disappointed, though. Buffett’s belief that stocks were overvalued at the end of 1987 turned out to be wrong. Over the following 20 years, the market posted a total return of nearly 500%, turning $10,000 invested in the market at the beginning of 1988 into nearly $60,000 by the end of 2007. That works out to a solid 9.3% compound annual growth rate (CAGR). Yet the same $10,000 invested in Berkshire Hathaway stock at the beginning of 1988 would have grown to nearly $200,000 over that period: a 15.8% CAGR!

BERKSHIRE HATHAWAY VS. S&P 500: 1988-2007, DATA BY YCHARTS.

In short, Buffett’s failure to act quickly and decisively immediately after the market plunged in 1987 didn’t hurt shareholders at all. It may have even helped. Just a year later, the Oracle of Omaha found two of the most successful investments of his career, buying shares of Coca-Cola and Freddie Mac. He continued to find attractive opportunities to deploy Berkshire Hathaway’s capital over the next two decades.

High-quality stocks may not be cheap enough to make Warren Buffett pull out his elephant gun. But between its existing collection of premier businesses and a massive war chest that can be deployed whenever compelling investment opportunities do turn up, Berkshire Hathaway stock is still an excellent choice for long-term investors.

Author: Adam Levine-Weinberg

Source: Fool: It’s 1987 All Over Again for Warren Buffett and Berkshire Hathaway

If you can spare the $1,200 stimulus money you’ll receive this month, consider investing it in high-quality companies that are trading at a discount because of the COVID-19 pandemic.

Later this month, most Americans are set to receive direct deposits of up to $1,200 per adult, plus $500 for each child age 16 and under, as the federal government tries to jump-start an economy that has been stricken by the COVID-19 pandemic.

Some people desperately need this cash to make up for lost income. However, for those whose jobs were not disrupted by stay-at-home orders and who have good financial cushions already, these $1,200 stimulus payments are coming at a great time to invest in beaten-down stocks.

If you can spare the cash, TJX Companies (NYSE:TJX), Starbucks (NASDAQ:SBUX), and Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) are three high-quality companies trading at discounts. All three stocks have fallen by about 20%-25% since the market peaked in mid-February. However, all three are well positioned to bounce back in the years ahead.

TJX Companies: set to gain market share

In the short-term, TJX Companies faces the same plight as other consumer discretionary companies. On March 19, the off-price retail giant announced that it would close all of its stores worldwide for two weeks to help slow the spread of COVID-19. It also went above and beyond government mandates by closing its offices and distribution centers and temporarily shuttering its e-commerce sites.

With the pandemic still in full swing, it appears inevitable that TJX’s stores will remain closed for far longer than two weeks. That’s not good news, but it’s also not as bad as investors seem to fear. For one thing, TJX has a low-cost business model. Operating expenses totaled just $1.7 billion in last year’s first quarter, including discretionary costs like advertising. Thus, even if TJX continues paying staff indefinitely, the cost would be very manageable relative to the nearly $20 billion that has been knocked off of TJX’s market cap since the stock peaked.

Furthermore, TJX has ample liquidity to make it through the current crisis. As of early February, it had $3.2 billion of cash. It drew down $1 billion from its credit facility in March, suspended its share repurchase program, and recently issued $4 billion of new debt.

This reduces the pressure on TJX to quickly convert inventory to cash by implementing massive markdowns. Instead, it could follow the example of peers that routinely buy merchandise at the end of a season and pack it away in a warehouse until the following year. That would dull the gross margin erosion that a retailer would normally experience from exiting a season with too much inventory.

In the long run, T.J. Maxx, Marshalls, HomeGoods, and TJX’s other brands could make big market share gains as the COVID-19 pandemic forces weaker rivals to close their doors. That long-term opportunity outweighs the near-term risk for investors, especially with TJX shares trading about 25% below the all-time high they reached in February.

Starbucks will perk up quickly

Like TJX, Starbucks is also feeling plenty of short-term pain from COVID-19. Indeed, the pandemic started hurting Starbucks before most other U.S. companies, because of the coffee titan’s big presence in China. Comparable sales plunged 78% in China in February, as Starbucks was forced to close many of its stores there. Sales started to recover near the end of the month, but Starbucks still advised investors in early March that sales declines in China would reduce its quarterly earnings per share by $0.15 to $0.18.

IMAGE SOURCE: STARBUCKS.

The impact of COVID-19 is likely to be far greater in the U.S., because it is Starbucks’ largest market by far. Most Starbucks cafes remain open for drive-through and/or delivery service, even though the company has given employees the option to stay home through April 19 with full pay if they prefer. Still, drive-through and delivery operations won’t fully offset lost in-cafe sales.

However, unlike TJX, Starbucks doesn’t have to worry about an overhang of seasonal inventory that could crush gross margin. In addition, it has the financial resources to weather a temporary downturn. As of late December, it had more than $3 billion of cash and investments on its balance sheet, and it recently issued $1.75 billion of debt to further bolster its liquidity.

Most importantly, I don’t expect COVID-19 to disrupt Starbucks’ long-term growth trajectory. While some analysts appear to be concerned about the rise of a “stay-at-home culture,” I believe there will be pent-up demand for away-from-home experiences once it is safe to mingle in public. In another demonstration of the resilient demand for its offerings, Starbucks had to end a brief experiment with offering take-out service in its cafes a couple of weeks ago because too many people were congregating in its stores. In short, Starbucks is likely to return to full strength over the next year or two, enabling a rebound in its share price.

A big opportunity for Berkshire Hathaway

Berkshire Hathaway stock hasn’t fallen as much over the past six weeks as shares of TJX and Starbucks. However, Warren Buffett’s conglomerate faces even less risk from COVID-19 than TJX and Starbucks.

To be sure, some of Berkshire Hathaway’s wholly owned industrial and consumer goods subsidiaries will be hurt by the COVID-19 pandemic. Furthermore, its stock portfolio (nominally worth about $250 billion at the beginning of 2020) has suffered significant paper losses this year.

That said, the pandemic could actually lead to better results in some parts of Berkshire’s business. For example, its GEICO insurance subsidiary could see lower auto insurance claims due to far fewer cars being on the road right now. Moreover, Berkshire entered 2020 with cash and short-term investments of $128 billion — more than a quarter of its market cap — most of which is available for investment.

In recent years, Warren Buffett has struggled to find good deals in the stock market to deploy Berkshire Hathaway’s growing cash stockpile. However, the current stock market carnage represents a great opportunity for him to find bargains, just as he did during the 2008 financial crisis. Buying Berkshire Hathaway stock allows you to latch on to Buffett’s investing acumen — and his access to private-market deals.

Right now, I don’t own shares of TJX, Starbucks, or Berkshire Hathaway. But all three are near the top of my watch list for April. If you can spare your $1,200 stimulus check — as I can — all three of these companies are likely to be great long-term investments.

Author: Adam Levine-Weinberg

Source: Fool: 3 Stocks to Buy With Your $1,200 Stimulus Check That Are No Joke

Three months ago, Boeing (NYSE:BA) reported a huge loss due to a one-time charge to cover compensation to customers related to the Boeing 737 MAX grounding. The aerospace giant’s cash flow turned negative, as well.

On Wednesday, Boeing revealed that it returned to profitability last quarter. Nevertheless, in many ways, the company’s third-quarter earnings report was even worse than its Q2 results. The 737 MAX remains grounded — with no firm schedule for recertification yet — and two of Boeing’s other commercial jet programs suffered setbacks.

Boeing posts a profit, but cash flow takes a turn for the worse

Boeing’s revenue plunged 21% year over year in the third quarter, falling to $20 billion, due to 737 MAX deliveries being suspended indefinitely. The company has burned through virtually its entire backlog of prior-generation 737s, so it delivered just five 737s last quarter, down from 138 in Q3 2018. This accounted for more than 100% of its revenue decline in the quarter.

While Boeing’s commercial airplanes division logged a $40 million loss for Q3 — with an increase in projected costs for the 737 program offsetting profits from other aircraft families — at least its defense and services businesses performed well. Those two segments achieved a combined operating profit of $1.4 billion. The net result was that core earnings per share (EPS) returned to positive territory at $1.45, down 59% year over year. Analysts had expected core EPS of $2.09.

Unfortunately, cash flow fell further into negative territory last quarter. Boeing burned a surprisingly modest $1 billion during the second quarter, but cash burn accelerated to $2.9 billion in the third quarter. The company also paid nearly $1.2 billion of dividends, further stressing its balance sheet.

Boeing ended the third quarter with $10.9 billion of cash and investments on its balance sheet, giving it plenty of liquidity. However, its debt load jumped to $24.7 billion, up from $19.2 billion a quarter earlier and $13.8 billion at the beginning of 2019. That number will likely continue to rise for at least one more quarter, if not two.

More setbacks acknowledged

Earlier this week, Boeing delivered its final 737 MAX software and training updates to the Federal Aviation Administration (FAA) for evaluation. It will take weeks to prepare for a certification test flight and — assuming all goes well — another month after that to recertify the 737 MAX, according to FAA chief Steve Dickson. This suggests that the grounding order won’t be lifted until at least mid-December, later than what Boeing had projected as recently as this summer.

Boeing still hopes that it will be able to resume 737 MAX deliveries before year-end and ramp up to a production rate of 57 per month over the next year or so (compared to 42 per month today). However, the company has little margin for error if it is to achieve those targets.

On Wednesday, Boeing also acknowledged that delays in certifying the new engines for the upcoming 777X model will push the first delivery from late 2020 to early 2021, at best. This will reduce the total number of 777-family deliveries next year.

Finally, Boeing said that it will reduce 787 Dreamliner production from 14 per month to 12 per month in late 2020 for a period of approximately two years. The company cited the current global trade environment. Specifically, China is holding up expected orders for the 787 due to its ongoing trade war with the U.S.

Steer clear of this stock

Boeing stock rose about 1.5% on Wednesday, as of noon EDT. This could best be characterized as a relief rally after new revelations about Boeing’s handling of the 737 MAX MCAS system caused the stock to plunge 10% in the span of two days over the past week. Investors were particularly happy that Boeing didn’t change its estimate of customer compensation costs and didn’t announce a complete suspension of 737 MAX production.

That said, even at its marked-down price, Boeing stock does not look attractive. The delayed entry into service of the 777X and the pending production slowdown for the 787 line will weigh on cash flow over the next few years, partially offsetting the windfall from delivering the already-built 737 MAX jets in Boeing’s inventory. A substantial chunk of what’s left will be needed to pay legal bills and fund the purchase of an 80% stake in Embraer’s commercial jet business.

Moreover, the 737 MAX is Boeing’s biggest growth driver — or at least it was prior to the pair of fatal accidents that led to its grounding. It’s too early to know how much long-term damage the 737 MAX franchise has sustained. Without more clarity on how the 737 MAX fiasco will impact Boeing’s long-term growth, there’s no reason for investors to bet on Boeing stock at its current valuation.

Author: Adam Levine-Weinberg

Source: Fool: Boeing’s Earnings Go From Bad to Ugly

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