JC Penney to rally 26 percent on Trump's 'middle-class spending resurgence,' Bank of America says

Published Fri, Dec 2 201612:15 PM ESTUpdated Fri, Dec 2 201612:21 PM EST

Bank of America on Friday upgraded J.C. Penney to buy from neutral, predicting an inflection point in earnings and cash flow as the retailer broadens its product offerings, and reaps of the benefits of a "middle-class spending resurgence" under President-elect Donald Trump. "We think JCP will drive industry-leading same store sales growth, primarily due to moves into nonapparel categories, and margin improvement as it fixes legacy supply chain issues," equity analyst Lorraine Hutchinson wrote in a research note. "An economic resurgence in the middle class under the Trump administration would provide upside to our outlook," she said. After treading water for five years, shares of J.C. Penney have surged 48 percent in 2016, positioning the stock for its best yearly gain since 2004. J.C. Penney, 1 year Source FactSet The inflection point in sales would likely take place in the fourth quarter of 2016, Hutchinson said, explaining that J.C. Penney's focus on products such as home, beauty, plus sizes and value, are paying off. "We have the most conviction in J.C. Penney's efforts to diversify into appliances and focus on beauty and special sizes (which carry less online threat). Investments in sourcing and speed to market will enable it to respond quickly to unfavorable weather and fashion missteps," the analyst wrote. As sales increase, cash flow will rise, allowing the retailer to pay off its debt, which has been the main reason holding back the stock, according to Bank of America. "We expect strengthening comps to drive earnings upside and free cash flow, allowing for debt repayment and stock appreciation," wrote Hutchinson. At the current levels, she says that J.C. Penney has $183 million in cash and $1.77 billion of "revolver capacity." That compares with $885 million in debt maturing over the next three years, plus $162 million drawn on its revolver. "Our forecast assumes J.C. Penney can generate $1.3bn of free cash flow over the next three years driven primarily by profitability improvement, which more than covers debt maturities of $1.15bn. The company's planned home office and warehouse sales should provide incremental protection from any profitability volatility or shortfalls." she said. In the next 12 months, Bank of America predicts the stock could trade as high as $12, implying a gain of 26 percent from here. — CNBC's Michael Bloom contributed to this story.

A shopper browses clothing at a JC Penney store in Queens, New York.

Michael Nagle | Bloomberg | Getty Images

"We think JCP will drive industry-leading same store sales growth, primarily due to moves into nonapparel categories, and margin improvement as it fixes legacy supply chain issues," equity analyst Lorraine Hutchinson wrote in a research note.

"An economic resurgence in the middle class under the Trump administration would provide upside to our outlook," she said.

After treading water for five years, shares of J.C. Penney have surged 48 percent in 2016, positioning the stock for its best yearly gain since 2004.