ARGUS MARKET DIGEST

Independent Equity Research Since 1934

2017 - DJIA: 24,719.22

MONDAY, MARCH 12, 2018
1934 - DJIA: 104.04 MARCH 9, DJIA 25,335.74
UP 440.53

Good Morning. This is the Market Digest for Monday, March 12, 2018, with analysis of the financial markets and comments on
International Game Technology PLC, Marvell Technology Group Ltd., Qualcomm Inc., and J.C. Penney Co. Inc.

IN THIS ISSUE:
* Focus List: International Game Technology PLC: Maintaining BUY and $35 target (John Staszak)
* Growth Stock: Marvell Technology Group Ltd.: Solid finish to FY18; reiterating BUY rating (Jim Kelleher)
* Growth Stock: Qualcomm Inc.: Dividend hike amid Broadcom battle; reaffirming BUY (Jim Kelleher)
* Value Stock: J.C. Penney Co. Inc.: Reiterating HOLD following 4Q results (Deborah Ciervo)

MARKET REVIEW:
Friday’s nonfarm payrolls report, which was strong without igniting inflation concerns, was greeted warmly by the major
benchmarks. The Dow Jones Industrial Average and Nasdaq Composite both rose 1.8%, while the S&P 500 was up 1.7%. Stocks
also climbed for the week in which the bull market had its ninth anniversary, with gains of 4.2% for the Nasdaq, 3.5% for the S&P
500 and 3.3% for the Dow. The Nasdaq has had a stellar start to 2018, rising 9.5%, while the S&P 500 and Dow are up 4.2% and
2.5%, respectively.
Friday’s nonfarm payrolls report showed 313,000 jobs were created in February, well above the 210,000 consensus and
the six-month trend of 231,000. Following a 2.9% spike in year-over-year wage inflation in the January report, which triggered
extreme market volatility, average hourly earnings in the February report showed a more modest 2.6% growth rate. As the job
market attracts sidelined workers, the labor force participation rate also increased to 63%. Meanwhile, demonstrating further
underlying economic strength, revisions added 54,000 jobs to the past few month’s payroll reports. Tax cuts appear to be driving
near-term job growth, and the February report bolsters the case for Fed rate hikes, the first of which is widely expected later in
March. Despite the more subdued reading on wage inflation, the 10-year Treasury yield pushed higher on Friday, ending at 2.90%,
and up from 2.86% the prior week.
Oil prices climbed 3.3% on Friday, to $62.12 per barrel, rebounding from losses earlier in the week, and are now up 3.4%
for the year. Friday’s gain was helped by a report that the number of active drilling rigs had declined. After a tumultuous period
between late January and mid-February, the equity markets have benefited from a return to the risk-on environment of the past
year. We believe equities continue to have a handful of tailwinds in place. Jobs growth has found a resurgence, potentially related
to the recently enacted tax cuts, which may also begin to have a favorable impact on consumer spending, helping the Consumer
Discretionary sector, and will result in strong year-over-year earnings comparisons when first-quarter earnings are reported next
month. Rising prices for commodities amid global demand are helping the Materials and Industrials sectors, while higher interest
rates are favorable for the Financial sector. And while the Trump administration’s tariffs on steel and aluminum were a brief
concern, announced exemptions for North American trading partners provided some relief.
Among our market indicators, our technical indicators bounced back sharply from bearish to neutral last week as NYSE
breadth surged 0.85 standard deviations, the largest jump since the February low. CBOE trading measures also surged on a huge
reversal in put/call volume, which was evidence of short covering. Our strategic composite also moved higher within a bullish/
positive trading range. Market internals benefited from a moderate rise in small-cap stocks, and weak Consumer Staples and
Utilities sectors, although cyclical stocks were split with relative strength in Technology but weakness in consumer cyclicals and
Industrials. Market externals saw a small rise on strength in Australian versus Japanese stocks and currencies, better emerging
market stocks versus developed, and a gain in industrial materials.

A R G U S R E S E A R C H C O M P A N Y • 6 1 B R O A D W- A
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 MARKET DIGEST
In this week’s economic calendar, Monday brings the treasury budget for February. On Tuesday the consumer price index
for February will be released. Wednesday brings business inventories for January, as well as final demand on the producer price
index and retail sales for February. On Thursday, import and export prices for February and the housing market index for March
will be released. Friday brings housing starts and industrial production for February, and preliminary consumer sentiment for
March.
Last week, Argus analysts upgraded Booking Holdings (BKNG), Quest Diagnostics (DGX), Domino’s Pizza (DPZ), and
Splunk Inc. (SPLK) to BUY from HOLD. They also initiated coverage of Marvel Technology Group (MRVL), a fabless
semiconductor provider, with a BUY rating. The average stock in the Argus universe gained 3.1% last week. The largest
percentage gainers were Autodesk Inc. (ADSK; HOLD; +19.9%), Tesaro Inc. (TSRO; BUY; +18.1%) and Wynn Resorts
(WYNN; BUY; +15.8%), while the largest percentage decliners were Kroger Co. (KR; BUY; -12.0%), JC Penny Co. (JCP;
HOLD; -11.9%), and Mattel Inc. (MAT; HOLD; -10.5%). (Stephen Biggar)

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 MARKET DIGEST
INTERNATIONAL GAME TECHNOLOGY PLC (NYSE: IGT, $29.21) ...................................... BUY
IGT: Maintaining BUY and $35 target
* Our optimism reflects the company’s solid earnings and free cash flow, continued efforts to reduce debt, and
steadily growing lottery business.
* In addition, although casinos have been slow to upgrade their equipment in recent years, we expect IGT to benefit
from the gradual transition to server-based gaming.
* Management projects 2018 EBITDA of $1.7-$1.8 billion, compared to a prereporting consensus estimate of $1.72
billion and $1.68 billion in 2017.
* We are reiterating our 2018 EPS estimate of $1.70 and setting a 2019 forecast of $1.85.
ANALYSIS
INVESTMENT THESIS
We are maintaining our BUY rating and $35 target price on Focus List selection International Game Technology PLC
(NYSE: IGT). Our optimism reflects the company’s solid earnings and free cash flow, continued efforts to reduce debt, and
steadily growing lottery business. In addition, although casinos have been slow to upgrade their equipment in recent years, we
expect IGT to benefit from the gradual transition to server-based gaming. Our long-term rating is also BUY as we expect recurring
lottery revenue and growth in the gaming business to result in strong revenue and earnings over time.
RECENT DEVELOPMENTS
IGT reported 4Q17 results on March 8. Adjusted EPS fell to $0.02 from $0.88 a year earlier, below the consensus estimate
of $0.39. Adjusted EPS excluded a one-time noncash tax benefit of $0.37 per share. Including this benefit, EPS matched the
consensus forecast.
Revenue of $1.35 billion rose 2% from the prior year, above the consensus estimate of $1.25 billion. Excluding the sale
of DoubleDown Interactive and an upfront payment from Italian Lottery authorities in the prior-year period, revenue was up 3%.
Same-store lottery revenue, excluding Italy, rose 8.3% in 4Q17, while lottery revenue in Italy rose 7%. Driven by strong growth
in both the lottery and gaming businesses, International revenue increased 27%. Adjusted EBITDA rose from $422 million to $452
million, and topped our estimate of $450 million. The consensus estimate had called for adjusted EBITDA of $440 million.
Reflecting a lower cost of product sales and lower SG&A expense, the adjusted EBITDA margin rose to 33.6% from 31.0% a year
earlier. The number of diluted shares outstanding rose to 204 million from 203 million. Interest expense fell to $114 million from
nearly $116 million.
For all of 2017, revenue decreased 4% to $4.9 billion and adjusted earnings fell to $0.86 from $2.33. Full-year adjusted
EBITDA totaled $1.68 billion, at the top of management’s $1.64-$1.68 billion range.
EARNINGS & GROWTH ANALYSIS
Management projects 2018 EBITDA of $1.7-$1.8 billion, compared to the prereporting consensus estimate of $1.72
billion. We are maintaining our 2018 EBITDA estimate of $1.78 billion. We are also reiterating our 2018 EPS estimate of $1.70
and setting a 2019 estimate of $1.85. Our long-term earnings growth rate forecast is 7%.
FINANCIAL STRENGTH & DIVIDEND
Our financial strength rating on IGT is Medium, the midpoint on our five-point scale. IGT had $1.06 billion in cash and
equivalents and restricted cash and investments at the end of 4Q17. Reflecting a significant decline in shareholders’ equity, the
long-term debt/capitalization ratio rose to 74.2% at the end of 4Q17 from 68.3% at the end of 4Q16. As noted above, the EBITDA
margin rose to 33.6% in 4Q17 from 31.0% a year earlier.
Net debt declined from $7.6 billion at the end of 4Q16 to $7.3 billion at the end of 4Q17. Management would like to reduce
net debt to less than 4.5-times EBITDA in the near term and to less than 4.0-times by 2018. In view of management’s 2018 EBITDA
guidance, this goal appears achievable.
IGT pays a quarterly dividend of $0.20 per share, or $0.80 annually, for a yield of about 2.7%. Our dividend estimates
are $0.88 for 2018 and $0.96 per share for 2019.

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 MARKET DIGEST
MANAGEMENT & RISKS
Marco Sala is the company’s CEO and Alberto Fornaro is the CFO. Mary Hart, the company’s CEO prior to the 2015
merger with GTECH S.p.A., continues to serve on the board. Mr. Sala works closely with Marco Drago, chairman of a private
equity firm that owns 52% of IGT.
Risks to our estimates and price target include terrorist attacks or terrorist threats that could disrupt tourism. Other risks
include lower capital expenditures by casinos and delayed regulatory approval of new or expanded gaming operations. Increased
capacity could also lower the number of gamblers at individual casinos. In addition, a new downturn in the economy and an
accompanying reduction in discretionary income could hurt gaming demand.
COMPANY DESCRIPTION
International Game Technology PLC designs, manufactures, and markets electronic gaming equipment. Its GTECH
division designs and markets lottery systems to lotteries worldwide. In April 2015, International Game Technology was acquired
by Italian gaming company GTECH S.p.A. in a transaction valued at $6.4 billion. The transaction was financed with $4.7 billion
in cash and stock and included the assumption of $1.7 billion in debt. The merged company operates as International Game
Technology PLC.
By 2018, the new company, which is based in the U.K., expects to generate EBITDA of nearly $2 billion. With a market
capitalization of $5.9 billion, IGT shares are generally considered mid-cap growth.
VALUATION
On March 8, IGT shares rose 7% following stronger-than-anticipated fourth-quarter revenue and EBITDA and favorable
2018 guidance. The shares are trading near the top of their 52-week range of $17-$30, and at an EV/EBITDA multiple of 8.8, above
the average multiple of 8.0 prior to the 2015 merger with GTECH S.p.A. However, we believe that a higher valuation is warranted
based on the merged company’s solid earnings and free cash flow, continued debt reduction efforts, and strong global lottery
business. As such, we are maintaining our BUY rating with a target price of $35.
On March 9, BUY-rated IGT closed at $29.21, down $0.65. (John Staszak, CFA, 3/9/18)

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 MARKET DIGEST
MARVELL TECHNOLOGY GROUP LTD. (NSM: MRVL, $24.34) ............................................. BUY
MRVL: Solid finish to FY18; reiterating BUY rating
* Marvell Technology Group capped its January 2018 fiscal year with a solid fiscal fourth quarter.
* The company has improved execution by tightening its focus on value-added opportunities, while exiting markets
where it lagged.
* The planned acquisition of Cavium makes strategic sense for Marvell and will substantially increase its total market
opportunity.
* Although MRVL shares have moved higher in the past year, our analysis suggests the stock is still undervalued
compared to peers and based on historical comparable valuations and cash flow growth prospects.
ANALYSIS
INVESTMENT THESIS
BUY-rated Marvell Technology Group Ltd. (NSM: MRVL) capped its January 2018 fiscal year with a solid fiscal fourth
quarter. Revenue for 4Q18 totaled $615 million and grew 8%, while non-GAAP EPS of $0.32 was up 49% year-over-year. Both
metrics were ahead of consensus.
During the quarter, Marvell delivered mid-single-digit growth in storage and networking. The strong storage results bode
well for memory companies exposed to the HDD and SSD markets, including Seagate and Western Digital in HDDs and Micron.
The company’s connectivity business, despite a sequential seasonal decline, posted strong double-digit annual growth, reflecting
strong execution and potential share gains.
The company has improved execution by tightening its focus on value-added opportunities. Marvell has also exited
markets where it lagged, such as mobile device basebands. CEO Matt Murphy lauded the “tremendous progress in the
transformation of Marvell,” which should accelerate with the planned acquisition of Cavium, announced in November 2017.
Cavium is a provider of network processors, network security solutions, ARM server processors, DCI (data center
interconnect) solutions, Ethernet connectivity, and other products.
We believe the Cavium purchase makes strategic sense for Marvell. The acquisition of Cavium would add a leading HBA
(server & storage connectivity) business to Marvell’s already strong storage platform. It would also add complementary assets
in networking, DCI, connectivity, and other areas, with minimal overlaps in products, markets and customers. Acquiring Cavium
will significantly expand Marvell’s total addressable market while creating room for further efficiencies and synergies.
Although MRVL shares have moved higher in the past year, our analysis suggests the stock is still undervalued compared
to peers and based on historical comparable valuations and cash flow growth prospects. Given the company’s gathering
momentum in key markets as well as attractive valuations, we believe MRVL shares warrant a BUY rating. We are reiterating
our 12-month target price of $28.
RECENT DEVELOPMENTS
The MRVL shares are up 13% so far in calendar 2018, compared with a 10% gain for the peer group of Argus covered
semiconductor companies. The shares rose 54% in 2017 versus 35% for Argus peers, and recovered by 61% from trough levels
in 2016. The shares declined 37% in 2015, compared to a 6% gain for peers, and edged up 5% in 2014.
For fiscal 4Q18, Marvell posted revenue of $615 million, which was up 8% year-over-year and flat with fiscal 3Q18.
Revenue was above the $610 million midpoint of management’s $595-$625 million guidance range, and also above the $611
million consensus forecast. Non-GAAP EPS for 4Q18 totaled $0.32 per diluted share, up 49% year-over-year and down $0.02
on a sequential basis. Non-GAAP EPS was toward the high end of the $0.29-$0.33 guidance range and one cent above the
consensus forecast.
Marvell participates in Storage (52% of FY18 revenue), Networking (25% of revenue), and Connectivity (15% of
revenue); the All Other category represented 8% of FY18 sales.
In the storage market, Marvell is a leading supplier of HDD controllers, HDD controller SoCs, SSD controllers, and
additional components used in memory drives. Other storage products include SATA port multipliers; redundant array of
independent disk controllers for SATA, SAS, and NVMe; and converged storage processors.
For fiscal 4Q18, Storage revenue of $324 million was up 5% year-over-year and increased 3% sequentially. According
to CFO Jean Hu, storage revenue growth was driven by SSD products for client applications and by both HDD and SSD products
for the enterprise and the data center markets.

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 MARKET DIGEST
CEO Matt Murphy, who joined the company 19 months ago, called 4Q18 a record quarter for the company’s SSD
solutions. The company is also progressing in the NVMe market. In HDD, new customer technologies and Marvell technologies
are unlocking density gains. Given that Marvell concludes its quarter one month after the major HDD and SSD companies such
as Seagate and Western Digital, strength in these markets bodes well for calendar first-quarter results among the memory
companies.
In Networking, Marvell provides a broad range of Ethernet switches; Ethernet physical layer transceivers (PHYs); and
single-chip network interface devices. For embedded applications Marvel provides ARM processors in SoC form factor targeted
at multiple connected home, SMB and enterprise markets. Fiscal 4Q18 Networking revenue of $155 million was up 5% year-over-
year and increased 3% sequentially. The CFO attributed growth to new products in Ethernet switch, PHY and embedded
applications. Murphy noted that absent legacy networking (mainly mobile) from all comparisons, growth was higher.
In the connectivity market, Marvell provides WiFi solutions, including WiFi/Bluetooth combos in SoC form factors.
Additional products include single-stream 1x1 and multi-stream 2x2 and 4x4 MIMO (multi input, multi output) devices; radio
control; processing; and RF solution. Fiscal 4Q18 connectivity revenue of $86 million surged by 26% annually, while pulling back
a seasonal 16% from fiscal 3Q18 (the holiday-build quarter). Growth was primarily driven by voice-enabled and home-streaming
devices. In a crowded market with established leaders, Marvell is seeking to distinguish itself in the high-performance market.
The Other segment includes SoCs for printers; applications processors for non-mobile applications in markets including
IoT and various embedded applications; and a sliver of the former mobile-device application processor business. Other segment
revenue of $50 million (8% of total) was up 10% annually and 5% sequentially. Other sales topped internal expectation by about
$2 million, driven by order activity and shipment timing.
The CEO provided a limited update on the announced Cavium acquisition. Since the November 2017 announcement,
both companies have been actively working on integration planning. On the regulatory front, the Hart Scott Rodino waiting period
has expired. MOFCOM and CFIUS reviews are underway, because Marvell is Bermuda-based.
On 11/20/17, Marvell Technology Group Ltd (NGS: MRVL) and Cavium, Inc. announced a definitive agreement to
combine. The agreement, approved by the boards of both companies, calls for Marvell to acquire all outstanding shares of Cavium
stock at an exchange rate of $40 per share in cash and 2.1757 shares of MRVL stock for each CAVM share.
Assuming achievement of the usual regulatory approvals, the two companies are targeting deal close for some time in
mid-2018. Marvell has been domiciled in Bermuda since 1995; acquisition of U.S. companies by foreign companies often takes
longer than comparable all-U.S. deals. The deal size is relatively small, however. Management of both firms believe that their
status as component companies rather than systems companies should prevent any regulatory roadblocks.
Cavium represents an attractive and relatively inexpensive asset for Marvell as it seeks to position itself for next-
generation data center, 5G wireless, and future developments spanning IoT, AI, hyperscale data center, and high performance
computing. Upon completion of the transaction, Marvell would become an “infrastructure solutions powerhouse,” according to
CEO Matt Murphy.
Cavium began as a provider of MIPS-based network processor and network security solutions. The company acquired
QLogic, a maker of fiber channel (FC) host bus adaptors (HBAs) for storage network connectivity, as well as Ethernet connectivity
products. Based on a successful multi-year expansion strategy, Cavium has become a leader in networking and embedded
processors, both MIPS and ARM-based; security and server processors, data center interconnect switches; base station processors;
network virtualization cards; FC HBAs; Ethernet connectivity; and other products.
Management at Marvel and Cavium believe their portfolios are highly complementary and present limited overlaps in
products, markets and customers. Complementary portfolios and scale should enable the combined company to deliver end-to-
end solution.
The combination will alter Marvell’s product and customer mix while reducing over-reliance on storage. The new
Marvell would derive 46% of revenue from storage (where Cavium would contribute QLogic’s FC HBAs); 37% from networking
and processing; 11% from connectivity; and 6% from other. The biggest change would be in networking, where Cavium is a
leading supplier of network processors to Cisco; base station SoCs to Samsung; DCI solutions to multiple enterprise clients; and
other products.
In the data center, Marvell brings networking solutions and HDD/SSD controllers. Cavium brings Xpliant top of rack
switches for interconnect, ThunderX ARM server platforms, LiquidIO for line card virtualization, and Nitrox MIPS-based
security processors. Though just 10% of combined revenue, this business would be on track to grow rapidly.

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 MARKET DIGEST
By acquiring Cavium, Marvell will double its total available market (TAM) opportunity to $16 billion. The new Marvell
will have 20% share within this expanded TAM opportunity, with lots of room to grow. The new Marvell would have a combined
$3.4 billion in revenue.
The company is targeting high-single-digit top-line growth for multiple years. Gross margin would be in the 63% range
(non-GAAP), with a longer-term target of 65%. Operating margin (non-GAAP) will begin in the 25% range, before synergies;
the long-term goal is 35%. The deal will be immediately accretive, according to Marvell CFO Jean Hu (formerly CFO and two-
time interim CEO of QLogic, which was acquired by Cavium).
Marvell and Cavium are aiming to achieve $150-$175 million in manufacturing and operating synergies within 18
months. The combined company should quickly achieve synergies from eliminating duplicative costs, integrating facilities, and
volume purchasing.
The combination will enable scale in areas including R&D, engineering, process node development, and tape-out costs.
Both companies have been developing new processors in 10 nm and 7 nm process node; that process will proceed more efficiently
in a single operation. Revenue synergies, though not modeled, would be natural for two companies operating in adjacent markets
(data center and service provider) yet with minimal customer overlap.
Although MRVL shares have moved higher in the past year, our analysis suggests the stock is still undervalued compared
to peers and based on historical comparable valuations and cash flow growth prospects. Given the company’s gathering
momentum in key markets as well as attractive valuations, we believe MRVL shares warrant a BUY rating. We are reiterating
our 12-month target price of $28.
EARNINGS & GROWTH ANALYSIS
For fiscal 4Q18, Marvell posted revenue of $615 million, which was up 8% year-over-year and flat with fiscal 3Q18.
Revenue was above the $610 million midpoint of management’s $595-$625 million guidance range, and also above the $611
million consensus forecast. Non-GAAP EPS for 4Q18 totaled $0.32 per diluted share, up 49% year-over-year and down $0.02
on a sequential basis. Non-GAAP EPS was toward the high end of the $0.29-$0.33 guidance range and one cent above the
consensus forecast.
For all of fiscal 2018, Marvell generated revenue of $2.42 billion, which was up 1% year-over-year from $2.39 billion
for FY17. On sharply improved gross .margin and operating efficiencies, non-GAAP EPS for FY18 of $1.24 per diluted share
was up 98% year-over-year from $0.60 per diluted share for FY17.
For 1Q18, Marvell guided for revenue of $585-$615 million and non–GAAP EPS of $0.29-$0.33. At guidance midpoints,
revenue would be up 4% and non-GAAP EPS would be up over 30%.
We are raising our 2019 non-GAAP EPS projection to $1.37 per diluted share, from $1.35. We are implementing a FY20
non-GAAP EPS projection of $1.53. Our annualized EPS growth rate forecast is 12%.
FINANCIAL STRENGTH & DIVIDEND
Our financial strength rating on Marvell is Medium-High. Although the company carries no debt and appears to be
operating more efficiently, the company’s past accounting issues as well as strategic missteps in the mobile baseband business
argue for a more conservative rating.
Cash, equivalents and short-term investments were $1.84 billion at 4Q18. Cash, equivalents and short-term investments
were $1.69 billion at the end of FY17, $2.28 billion at the end of FY16, $2.53 billion at the end of FY15, and $1.97 billion at the
end of FY14.
Marvell has no debt.
The company engaged in significant share repurchase activity in FY14, reducing its basic shares outstanding to 497
million at year-end from 555 million at FY13 fiscal year-end. Since then the company has repurchased stock mainly as an offset
to share-based compensation and other share grants. We expect the company to maintain a modest share repurchase program going
forward.
Marvell implemented a quarterly dividend of $0.06 per common share in 2013. The board has not raised the dividend
since. The annual dividend of $0.24 provides a yield slightly above 1.0%. We estimate coverage of the dividend of about 5.5-times
based on cash flow from operations and about 5.0-times based on free cash flow.
Our dividend estimate are $0.24 for both FY19 and FY20.

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 MARKET DIGEST
MANAGEMENT & RISKS
CEO and President Matt Murphy has served in that role since 2016, when he took over for the husband-and-wife team
who founded the company in 1995 but were forced to resign following an accounting scandal. Jean Hu, formerly CFO and two-
time interim CEO of QLogic, is CFO. Dan Christman is EVP Storage Group; Chris Koopmans is EVP Networking & Connectivity
Group. Richard Hill is chairman of the board.
The taint of Marvell’s accounting scandal has receded. Should another such issue emerge, however, twice-bitten
investors would likely react fiercely. We have no reason to believe that the current management team and board, chastened by
that misadventure, would create a culture in which such malfeasance would resurface.
The acquisition of Cavium will create financial strains and introduce risks related to cultural integration, attaining
targeted efficiencies, and retaining acquired customer relationships. We believe Marvell and Cavium are logical partners for
combination, given complementary rather than overlapping products, markets and customers, and that this lessens risks that the
combination will fail to meet objectives.
Marvell faces the risks of any small company attempting to operate in multiple product niches and end markets. Recent
success in improving operation margins suggests Marvell is not over-reaching.
Finally, Marvell has customer concentration risk in the HDD controllers business. Cultivation of new markets and the
Cavium acquisition should help reduce this risk.
COMPANY DESCRIPTION
Marvell Technology Group Ltd. was founded in 1995. Domiciled in Bermuda, Marvell’s headquarters is based in Santa
Clara, CA. Marvell is a fabless semiconductor provider of high performance ASSPs (application-specific standard products) for
use in storage, networking, connectivity and other applications. Primary products include HDD and SSD controllers; additional
components used in memory drives; Ethernet switches; Ethernet PHYs; ARM processors in SoC format; WiFi and WiFi/
Bluetooth combo chips; and embedded processors and SoCs. The company has rebounded from an accounting scandal in 2015.
In November 2017, Marvell announced a definitive agreement to acquire Cavium Inc.
INDUSTRY
Our rating on the Technology sector is Over-Weight. Technology is showing clear investor momentum, topping the
market in the year-to-date. At the same time, the average two-year-forward EPS growth rate exceeds our broad-market estimate
and sector averages, which has kept technology sector PEG valuations from becoming too rich.
Over the long term, we expect the Tech sector to benefit from pervasive digitization across the economy, greater
acceptance of transformative technologies, and the development of the Internet of Things (IoT). Healthy company and sector
fundamentals are also positive. For individual companies, these include high cash levels, low debt, and broad international
business exposure.
In terms of performance, the sector rose 12.0% in 2016, above the market average, after rising 4.3% in 2015. It strongly
outperformed in 2017, with a gain of 36.9%. It is performing largely in line with the market thus far in 2018, with a loss of 1.7%.
Fundamentals for the Technology sector look reasonably balanced. By our calculations, the P/E ratio on projected 2018
earnings is 19.6, above the market multiple of 18.7. Earnings are expected to grow 22.9% in 2018 and 29.4% in 2017 following
low single-digit growth in 2015-2016. The sector’s debt ratios are below the market average, as is the average dividend yield.
VALUATION
MRVL trades at 17.7-times our FY19 non-GAAP EPS estimate and at 15.9-times our FY20 forecast; the two-year-
forward P/E of 16.8 is below the average multiple of 18.5-times over the past five years. The two-year-forward relative P/E of
0.99 is now below the trailing five-year relative P/E of 1.01. Our comparable valuation range for MRVL is in the high teens to
low-$20s, slightly below current prices but in a clear rising trend.
Compared with its peer group, MRVL trades at discounts on absolute and relative P/E, EV/EBITDA, and PEGY. Our
forward-looking discounted free cash flow model points to a value in the mid- to upper $30s, in a rising trend.
Our blended valuation for MRVL is in the high $20s to low $30s, in a rising trend. Appreciation to our 12-month target
price of $28, including the dividend yield of 1.0%, implies a risk-adjusted total return in excess of our forecast total return for the
S&P 500 and is thus consistent with a BUY rating.
On March 9, BUY-rated MRVL closed at $24.34, up $0.02. (Jim Kelleher, CFA, 3/9/18)

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 MARKET DIGEST
QUALCOMM INC. (NGS: QCOM, $63.03)............................................................................... BUY
QCOM: Dividend hike amid Broadcom battle; reaffirming BUY
* Qualcomm recently announced a 9% increase in its quarterly dividend. A typically bland event, the increase this
year is heavily freighted amid the ongoing battle for control of the company.
* Broadcom took the unusual step of lowering its buyout offer after Qualcomm won a regulatory round and raised
its own bid for NXP Semiconductor.
* Qualcomm and Broadcom have been hurling furious allegations at each other since Qualcomm postponed its
annual meeting, reportedly at the prompting of a U.S. government agency.
* In our view, Broadcom has lost some of its enthusiasm for acquiring Qualcomm, and its path to winning board and
shareholder approval is tenuous. And even an approved deal would face antitrust and even national security
hurdles that may prove insurmountable.
ANALYSIS
INVESTMENT THESIS
BUY-rated Qualcomm Inc. (NGS: QCOM) has raised its dividend, a typically bland event that is more heavily freighted
amid the ongoing battle for control of the company. The battle with Broadcom, which first bid on Qualcomm in November 2017,
has grown increasingly heated, with charges and counter-charges now flying on an almost daily basis. Qualcomm has postponed
its annual meeting until 4/5/18, citing a federal government request. Meanwhile, Broadcom has claimed that Qualcomm feared
it would lose a vote on board composition.
Broadcom took the unusual step of lowering its bid after Qualcomm won a regulatory round and raised its own bid for
NXP Semiconductor. Based on that counter-intuitive strategy to win institutional holders’ approval, investors are wondering if
Broadcom has lost its appetite for Qualcomm. Broadcom shares are also down $34 since the company first bid on Qualcomm.
Increasingly, we doubt that this deal will pass regulatory muster, as it would concentrate an inordinate amount of mobile device
content in a single company.
As for the dividend, Qualcomm’s board has approved a 9% hike in the quarterly payout, to $0.62. That is a fairly routine
increase based on historical precedent; it was also in line with our estimates in terms of magnitude and timing. The company also
announced that independent director Jeffery Henderson would become chairman of the board, replacing Paul Jacobs. That move
will be seen as part of Qualcomm’s strategy to fend off Broadcom.
In our view, Broadcom has lost some of its enthusiasm for the acquisition, and its path to winning board and shareholder
approval is tenuous. And even an approved deal would face antitrust and even national security hurdles that may prove
insurmountable.
Meanwhile, Qualcomm is embroiled in a royalty battle with Apple, which is also indirectly tied into the Broadcom bid.
While QCOM shares are subject to many cross-currents having nothing to do with operations, that actually makes fundamental
performance more important. Despite the absence of substantial Apple licensing revenue, Qualcomm was able to post higher sales
in fiscal 1Q18, and is on track for relatively flat sales in 2Q18.
Weakness in QCOM shares has created a deep-value opportunity, though we caution that the risk of owning the shares
has increased. Investors willing to take on a range of risks but also potential benefits may be inclined to initiate or add to positions
in QCOM shares. We are reiterating our BUY rating to a 12-month target price of $75.
RECENT DEVELOPMENTS
QCOM shares are down about 3% in 2018, compared to a 10% gain for peers. QCOM declined 2% in 2017, compared
to a 31% simple average gain for a peer group of communications and information processing semiconductor companies in Argus
coverage. QCOM was up 30% in 2016, versus 60% for peers, and declined 33% in 2015, lagging the 9% gain for the peer group.
On 3/8/18, Qualcomm announced three items with varying degrees of relevance to its business development strategy —
both with respect to acquisition target NXP Semiconductor and its battle with Broadcom. The least tangential news was the 9%
increase in the quarterly dividend to $0.62. The March 2018 dividend hike marked the 16th consecutive year that Qualcomm has
increased its dividend. It usually announces increases in March and has raised the payout at a high single-digit rate since 2016;
previously, Qualcomm raised its dividend in low-double-digits.

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Second, in a move possibly designed to blunt one of Broadcom’s criticisms, Qualcomm announced that Jeffery
Henderson, an independent director since 2016, would become chairman of the board, effective immediately. Mr. Henderson
replaces Paul Jacobs, who has served as executive chairman since that role was established in 2014. Mr. Jacobs will remain on
the board. Qualcomm also discontinued the role of executive chairman, based on the view that an independent chairman was now
more appropriate. This change was undoubtedly influenced by the company’s desire to fend off the Broadcom bid, which it sees
as insufficient.
Qualcomm also extended the offering period for its cash tender off to purchase all of the outstanding common shares of
NXP Semiconductor N.V. (NGM: NXPI). The tender, based on the purchase agreement signed by the companies in October,
expires on 3/18/18.
This extension of the original offering period is the latest in a series of extensions as Qualcomm tries to convince
shareholders to tender their shares. Qualcomm, which initially offered $110 per share for NXP, raised its offer to $127.50 in
February 2018. NXP activist shareholder Elliott Management had deemed the original bid too low. As of 3/8/18, only 19% of NXP
shareholders had tendered, signaling that investors are holding out for a better bid.
The bid for NXP is intertwined with Broadcom’s bid for Qualcomm; the royalty battle with Apple is also related to this
increasingly convoluted saga. A recap of the main events shows that the cadence of actions and counter-actions, accusations and
counter-accusations between the two companies is accelerating in terms of frequency and ferocity.
In November 2017, Broadcom made an unsolicited $70 per share bid for QCOM shares. A week later, Qualcomm rejected
the bid, saying that the offer undervalued the company and that it would face resistance from regulators. Undaunted, in December,
Broadcom nominated a slate of 11 directors to Qualcomm’s board. Broadcom expected to nominate this slate at Qualcomm’s
annual meeting, which at the time was scheduled for 3/5/18. Qualcomm promptly rejected the slate, setting off a proxy battle.
On 2/5/18, Broadcom boosted its bid to $82 per share from $70, calling it a “best and final offer.” Broadcom indicated
that this offer, representing a total purchase price of $117 billion, would not be altered based on Qualcomm’s success or failure
in acquiring NXP.
Qualcomm rejected the sweetened bid and suggested that the two sides meet, with the proposed topic being the bid’s
“serious deficiencies in value and certainty.” Following that meeting – which occurred, ironically, on Valentine’s Day –
Qualcomm argued that Broadcom’s stance was inflexible, while Broadcom reiterated its “best-and-final” offer language and
offered no concessions.
On 2/20/18, Qualcomm raised its bid for NXP to $127.50 per share from $110. A day later, on 2/21/18, Broadcom
responded by lowering its offer for Qualcomm to $79 per share from $82.
The battle became even more complex when Qualcomm, citing a request from the U.S. government, announced on 3/
5/18 that it had delayed its shareholder meeting until 4/5/18. Qualcomm said that the postponement came at the request of the
Committee on Foreign Investment in the United States (CFIUS), which indicated that it needed more time to study the proposed
acquisition.
The two sides exchanged vituperative press releases, accusing each other of being dishonest or worse. Broadcom stated
it learned of the CFIUS investigation on 3/4/18; Qualcomm fired back that Broadcom had been “interacting with CFIUS for weeks
and made two written submissions” to the agency. Qualcomm accused Broadcom of “using rhetoric rather than substance to
trivialize and ignore” serious regulatory and national security issues. Qualcomm even suggested that CFIUS had identified
“national security risks” related to the transaction.
In November, Broadcom CEO Hock E. Tan met with President Trump, and announced Broadcom’s plan to relocate its
headquarters to the U.S. from Singapore. Less than two weeks later, Broadcom announced its intention to acquire Qualcomm. If
Broadcom transfers its headquarters and domicile to the United States, the CFIUS investigation would be null and void, as the
agency would no longer be investigating a foreign entity.
The CFIUS investigation may be the tip of the spear, so to speak, regarding U.S. anxiety about technology transfer to
China. Broadcom appears to be considering the spinoff or sale of Qualcomm’s technology licensing business, which is home to
the company’s considerable intellectual property. The U.S. is evidently concerned that stripping Qualcomm of its IP would
weaken the company and that, as a mere subsidiary of Broadcom, Qualcomm – and the U.S. – would lose their competitive edge
in the coming 5G standard. Specifically, in a 3/5/18 letter to Broadcom attorneys, a Treasury Department official raised concerns
that Broadcom’s planned changes in Qualcomm’s licensing structure “could result in a weakening of Qualcomm’s technological
leadership in a manner… detrimental to U.S. national security.”

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Even if Broadcom were to become a U.S.-based company, and even if U.S. authorities were to determine that changing
Qualcomm’s IP structure posed no risk to U.S. technological leadership in 5G or to overall national security, the deal might still
be blocked on antitrust grounds. At present, Broadcom is the number-one supplier of WiFi, WiFi-Bluetooth combo, and RF filter
semiconductors used in mobile devices. Qualcomm is the number-one provider of mobile modems, or basebands, and the number-
one provider of applications processors used in mobile devices.
Additionally, both companies are dominant across all smartphone tiers, with particular strength in the premium tier that
dominates U.S. handset sales. The company’s customers would not be happy to see their buying power diminished by the
concentration of so many vital components in the hands of a single entity. Apple may be an exception; the iPhone maker is
determined to see Qualcomm’s QTL business defanged.
Investors appear increasingly skeptical that this acquisition — the biggest of all technology deals — will ever happen.
The reduction in a bid for a reluctant suitor is almost unprecedented, particularly given that Qualcomm has vast resources to fight
on. The Street has expressed its displeasure with the increasingly hostile battle by pushing down Broadcom shares by 11% since
the initial offer in November 2017.
In other legal matters, we are unable to predict the timing of any resolution to the tangled Apple-Qualcomm fracas. Apple
will not be able to fully escape paying royalties to Qualcomm, though it could start sourcing modems exclusively from Intel. For
existing iPhone models, Qualcomm likely retains its sockets. Qualcomm could see a decline in iPhone modem market share, with
a corresponding gain for Intel.
Apple may also eliminate Qualcomm entirely in new models. In our 2/6/18 QCOM note, we estimated QTL revenue from
Apple at about $1.2-$1.3 billion, or about half the amount that Qualcomm has (in the past) obtained in royalty and licensing income
from Apple.
Moreover, Apple may not launch any new iPhone models until fall 2019, by which time the two companies may have
settled their differences. At some point, Apple and its suppliers will have to deliver withheld royalties, either in full or at a reduced
amount following a settlement.
Either way, this will represent significant “catch-up” EPS for Qualcomm. That would raise the company’s value for most
investors, though perhaps not for Broadcom. Meanwhile, one factor is increasing the urgency of a resolution for both Apple and
Qualcomm: the pending arrival of 5G networks and phones.
In summary, we think that Broadcom may have lost its enthusiasm for acquiring Qualcomm unless it can win the proxy
battle and buy Qualcomm on the cheap. Even if Broadcom pulled that off, which we see as unlikely, the deal would face antitrust
and potentially even national security concerns. Although most proposed technology acquisitions do take place, we think this one
could easily fail due to the multiple obstacles discussed above. We also think that Apple and Qualcomm will settle their dispute
before 5G becomes a major force in the market.
QCOM shares are subject to many cross-currents having nothing to do with operations. In our view, that actually makes
fundamental performance more important. Despite the absence of substantial Apple licensing revenue in fiscal 1Q18, Qualcomm
was able to post higher sales. Revenue rose 1%, as a 14% gain in equipment (semiconductor) and service revenue offset a 28%
annual decline in licensing & royalty income. With its highest margin business deeply impacted by withheld royalties, Qualcomm
saw a 17% drop in non-GAAP EPS in 1Q18.
Qualcomm is on track for relatively flat sales in 2Q18, again mainly reflecting withheld Apple royalty payments. Even
if the Apple legal battle drags on into next year, Qualcomm will lap the impact of the withheld royalties and post higher sales and
EPS in FY19.
EARNINGS & GROWTH ANALYSIS
For fiscal 1Q18 (calendar 4Q17), Qualcomm reported revenue of $6.07 billion, which was up 1% annually; revenue was
within the $5.5-$6.3 billion guidance range and topped the $5.93 billion consensus.
The GAAP gross margin expanded sequentially to 56.1% in 1Q18 from 55.1% in 4Q17, while narrowing from 59.3%
a year earlier. The decline reflected lost volume leverage on a decline in high-margin QTL revenue. The non-GAAP operating
margin expanded to 27.5% in 1Q18 from 26.5% in 4Q17 but declined from 34.6% a year earlier.
Non-GAAP EPS of $0.98 fell 17% from the prior year but topped the high end of the $0.85-$0.95 guidance range and
the $0.91 consensus forecast.
For all of FY17, Qualcomm had sales of $22.9 billion, down 7% from $24.0 billion in FY16. Non-GAAP EPS totaled
$4.28, down 4% from FY16.

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For 2Q18, Qualcomm forecast revenue of $4.8-$5.6 billion, which at the $5.2 billion midpoint would be flat to down 2%.
Non-GAAP EPS was forecast at $0.65-$0.75, compared to $1.34 in 2Q17 – the last “normal” quarter before Apple and its contract
manufacturers began withholding revenue.
We are modeling a more extended period of missing QTL royalties and, as a result, tighter QTL margins. Our FY18 non-
GAAP earnings forecast for Qualcomm is $3.65 per diluted share and our FY19 projection is $4.02.
We are not incorporating NXP into our non-GAAP estimates for FY18 or FY19; in our view, the deal is still far from
conclusion. Our estimates are also not indicative of industry or Qualcomm fundamentals and reflect our expectations that the
resolution of litigation with Apple and the unnamed licensee also withholding royalties, as well as any settlements with regulators,
will take place over an extended period and are inherently unpredictable.
Our long-term EPS growth rate forecast is 10%.
FINANCIAL STRENGTH & DIVIDEND
Our financial strength rating for Qualcomm is High, the top of our five-point scale. The NXP deal would represent a strain
for any company. Qualcomm could potentially fund nearly all of the deal with offshore cash should it choose to do so; however,
we expect QCOM to access credit markets to pay for a significant part of the acquisition. Qualcomm added approximately $10
billion in debt in 3Q17 in anticipation of NXP deal closing. We will monitor our financial strength ranking as final details emerge.
Note that Qualcomm’s withholding of $1 billion due Apple under the companies’ cooperation agreement has increased
cash by that amount and other current liabilities by the same amount. The launch of the RF 365 JV with TDK has bulked up assets,
as this JV is consolidated on Qualcomm’s financial statements.
Cash was $39.9 billion at the close of 1Q18. Cash was $39.8 billion at the end of fiscal 2017, $32.4 billion at the end of
fiscal 2016, $30.9 billion at the end of fiscal 2015, and $32.0 billion at the end of fiscal 2014.
Cash flow from operations was $4.79 billion in FY17, down from $7.40 billion in fiscal 2016. Cash flow from operations
was $5.5 billion in fiscal 2015, and free cash flow was $4.5 billion.
Debt was $22.8 billion at the end of 1Q18. Debt was $21.9 billion at the end of FY17, $11.8 billion at the end of FY16,
and $10.9 billion at the end of FY15. To pay for a major increase in its capital-return program, early in FY15 Qualcomm announced
plans to access the credit markets. Previously, Qualcomm had not had any debt since FY12.
Qualcomm’s capital allocation strategy targets a return of at least 75% of free cash flow to shareholders. Qualcomm has
returned a cumulative $57.5 billion to shareholders since 2007. Qualcomm repurchased $3.9 billion of its stock in FY16, $11.3
billion in FY15, and $4.55 billion in FY14.
On 3/8/18, Qualcomm announced a 9% increase in its quarterly dividend to $0.62 per share or $2.48 annually, for a yield
of about 4.0%. The March 2018 dividend hike marked the 16th straight year that Qualcomm has increased its dividend. Our
dividend estimates are $2.38 for FY18 and $2.56 for FY19.
MANAGEMENT & RISKS
Steve Mollenkopf has served as CEO since 2014. George Davis is CFO and Christiano Amon is president.
Former CEO Paul Jacobs has stepped down as executive chairman but will remain a member of the board. Jeffery
Henderson, an independent director since 2016, has become the company’s new chairman. The post of executive chairman has
been discontinued.
The suit and countersuit with Apple significantly increases risks for Qualcomm; in an unsuccessful outcome, Qualcomm
could end up paying a large legal bill and fine while also losing a major customer. However, the legal sparring may not ultimately
influence Apple’s business decisions, particularly if this spat is resolved quickly. Apple currently has only one other qualified
baseband supplier — Intel. Despite its huge fabrication infrastructure, Intel has been outsourcing baseband production and may
not be ready to supply chips for over 200 million phones.
In our view, Broadcom has lost some of its enthusiasm for acquiring Qualcomm. Its path to winning board and
shareholder approval is tenuous, and even an approved deal would face antitrust and even national security hurdles that may prove
insurmountable.
An ongoing risk for Qualcomm is that the KFTC and FTC investigations, along with an ongoing EU investigation, will
materially impact results. Regarding the FTC investigation, Qualcomm has in the past won court decisions related to allegations
that its marketing practices violated FRAND. For the EU investigation, the language regarding the use of rebates and incentives
for silicon sales smacks of a smaller vendor objecting to volume discounts for larger vendors (Apple and Samsung, for example).
In Korea, we expect Qualcomm to pay a fine and renegotiate royalty rates with Samsung and LG; the amount of the fine may be
negotiable.

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The acquisition of NXP is expensive, though it will be worth the price if it future-proofs the company against the
inevitable decline in the smartphone market. Qualcomm is in a nearly unique position of being able to finance the deal largely with
offshore cash should it choose to do so. Overall, we see risks and opportunities being evenly balanced or perhaps favoring
opportunities in this acquisition.
COMPANY DESCRIPTION
Qualcomm is a designer and manufacturer of advanced semiconductors for mobile phones and commercial wireless
applications. Qualcomm provides integrated solutions, including processors, GPS, WiFi, basebands and other applications, for
smartphones, tablets, and mobile PCs. Qualcomm has extended its leadership in the 3G CDMA wireless standard into the 4G LTE
niche. It derives substantial royalty and licensing revenue from its extensive intellectual-property portfolio for 3G and 4G
technologies.
INDUSTRY
Our rating on the Technology sector is Over-Weight. Technology is showing clear investor momentum, topping the
market in the year-to-date. At the same time, the average two-year-forward EPS growth rate exceeds our broad-market estimate
and sector averages, which has kept technology sector PEG valuations from becoming too rich.
Over the long term, we expect the Tech sector to benefit from pervasive digitization across the economy, greater
acceptance of transformative technologies, and the development of the Internet of Things (IoT). Healthy company and sector
fundamentals are also positive. For individual companies, these include high cash levels, low debt, and broad international
business exposure.
In terms of performance, the sector rose 12.0% in 2016, above the market average, after rising 4.3% in 2015. It strongly
outperformed in 2017, with a gain of 36.9%. It is performing largely in line with the market thus far in 2018, with a loss of 1.7%.
Fundamentals for the Technology sector look reasonably balanced. By our calculations, the P/E ratio on projected 2018
earnings is 19.6, above the market multiple of 18.7. Earnings are expected to grow 22.9% in 2018 and 29.4% in 2017 following
low single-digit growth in 2015-2016. The sector’s debt ratios are below the market average, as is the average dividend yield.
VALUATION
QCOM shares are trading at 16.9-times our FY18 non-GAAP EPS forecast and at 15.3-times our FY19 projection,
compared to an average P/E of 13.7 for FY13-FY17. The shares, which historically traded at a 15% discount to the market P/E,
now trade at an average 11% discount for FY17-FY18.
Our historical comparables model signals value in the low $60s, in line with current levels and down from past peaks
due to the reduced QTL contribution. Discounted free cash flow modeling signals value above $80, also in declining trend on
reduced royalty cash flows, but still above current levels.
Outside of disputes with major OEMs, revenue and EPS continue to recover across the broad base of customers based
on technology leadership at QCT and growth in the total addressable market and in reported devices. The potential acquisition
of NXP argues for a longer-term appraisal of the value that Qualcomm can generate in the coming decades. Legal issues remain
a wild card.
Appreciation to our 12-month target price of $75, along with the annualized dividend yield of about 4.0%, implies a risk-
adjusted return exceeding our benchmark forecast. We are reiterating our BUY rating on QCOM, while reminding investors of
the multiple risks (and opportunities) now in the shares.
On March 9, BUY-rated QCOM closed at $63.03, up $1.21. (Jim Kelleher, CFA, 3/9/18)

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J.C. PENNEY CO. INC. (NYSE: JCP, $3.27) ........................................................................ HOLD
JCP: Reiterating HOLD following 4Q results
* On March 2, J.C. Penney posted fiscal 4Q18 adjusted net income of $179 million or $0.57 per share. Adjusted EPS
fell 11.4% from the prior year but topped the consensus estimate of $0.47. Net sales rose 1.8% to $4.03 billion,
in line with expectations, while comparable sales rose 2.6%.
* Along with the 4Q results, management provided guidance for FY19. It expects comp sales to be flat to up 2% and
looks for adjusted EPS of $0.05-$0.25.
* We are maintaining our FY19 adjusted EPS estimate of $0.18 and setting an FY20 estimate of $0.26.
* Although the company is taking steps to restructure its merchandise assortment, close underperforming stores,
and bolster its Omnichannel business, we remain concerned about the impact of weak mall traffic and increased
competition in the department store sector.
ANALYSIS
INVESTMENT THESIS
We are maintaining our HOLD rating on J.C. Penney Co. Inc. (NYSE: JCP). We continue to expect merchandise that
may be less aspirational than a previous management team once imagined, but better suited to the company’s core middle-income
customers. In the near term, we also expect to see inventory quantities and new product offerings that are better matched to store
traffic and customer tastes, and note that the company is working to create a centralized pricing strategy and a flatter organizational
structure. JCP is also aggressively investing in omnichannel initiatives, a major component of its strategy to drive sales growth.
Still, our research and store visits suggest that JCP has substantial work ahead, especially in driving sales growth during a period
of flat to negative mall traffic and in competing in the very expensive “arms race” to improve e-commerce capabilities. In addition,
the company has not reported annual EPS growth since 2012 and has consistently missed its own guidance and consensus
estimates. We are maintaining our HOLD recommendation because we believe that the shares are trading at close to fair value.
However, we would consider a downgrade if the company continues to post weak sales and earnings.
RECENT DEVELOPMENTS
JCP shares have lost more than 47% over the last year and more than 5% year-to-date, while the S&P 500 has risen 2%
and 16%, respectively, during these periods.
On March 2, J.C. Penney posted 4Q18 adjusted net income of $179 million or $0.57 per share. Adjusted EPS fell 11.4%
from the prior year, but topped the consensus estimate of $0.47. Net sales rose 1.8% to $4.03 billion, in line with expectations,
and comparable sales rose 2.6%, driven by an increase in average unit retail pricing, units per transaction, and positive store traffic.
The quarter saw strong comps in the jewelry, home, footwear, handbags, and salon businesses as well as in Sephora cosmetics.
The 4Q gross margin improved by 50 basis points, while the operating margin declined to 6.1% from 6.9%. SG&A costs
were 23.4% of revenue, flat with the prior year, reflecting controlled marketing costs, store closures and reduced corporate
overhead, offset in part by lower credit income and higher incentive compensation.
For the full year, net sales fell 0.3% to $12.51 billion, while comparable sales rose 0.1%. Adjusted net income was $68
million or $0.22 per share, up from $24 million or $0.08 per share a year earlier. On a GAAP basis, JCP posted a net loss of $116
million, or $0.37 per share, due mainly to store closures and costs related to an early retirement program.
The company recently announced 360 layoffs and continues to close underperforming stores. It closed 141 stores in
FY18, and ended the year with a total of 872 stores. It expects to close an additional seven stores this year. It opened 70 new Sephora
locations in FY18, and now has 641 Sephora shops inside JCP stores. It plans to open 30 new Sephora shops in FY19.
Along with the 4Q results, management provided full-year guidance for FY19. It expects comp sales to be flat to up 2%
and looks for adjusted EPS of $0.05-$0.25.
EARNINGS & GROWTH ANALYSIS
We are maintaining our FY19 EPS forecast of $0.18 and setting an FY20 EPS forecast of $0.26.
JCP’s long-term goals are to generate annual net income of $400-$500 million and EPS of $1.40-$1.55, though it is
clearly still far from reaching these targets.

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FINANCIAL STRENGTH & DIVIDEND
Our financial strength rating for J.C. Penney is Low, the lowest rank on our five-point scale. The company lowered its
debt by $600 million in FY18 to $3.9 billion, though it still faces significant risks as its remaining debt matures. Free cash flow
in FY18 was $213 million. The company needs cash to service its debt and improve its e-commerce capabilities. It has been
increasing cash on hand through the closure of underperforming stores and the recent sale of a distribution center for $131 million.
The company funded a portion of its seasonal working capital needs with its asset-based lending facility (ABL) and ended FY18
with $458 million in cash and total liquidity of about $2.3 billion. It repaid the entire $400 million outstanding under its ABL
facility before the end of the year. JCP’s debt is rated B1/stable by Moody’s, B+/positive by S&P, and B+/stable by Fitch.
The company suspended its dividend in 2012 and is unlikely to restore it in the near term. It does not have a stock buyback
program.
MANAGEMENT & RISKS
Marvin Ellison, a former senior executive with Home Depot, became CEO on August 1, 2015 and chairman on August
1, 2016.
J.C. Penney is in a very competitive business and will have to excel in all aspects of merchandising – from design and
inventory management to store atmosphere and marketing – in order to consistently attract its target customers.
Amazon is a growing concern because the online giant is offering more private-label merchandise and has third-party
vendors who sell name-brand merchandise at very low prices. Amazon is also expanding its apparel offering, which represents
a near-term risk for JCP.
Even as management works to stabilize the business, retail is always a fight for market share, and that certainly won’t
diminish as JCP works to transform its business. Like most retailers, JCP is susceptible to changes in consumer spending, and
customers at broadline stores are currently spending cautiously, emphasizing autos and home improvements over apparel and
using the internet to look for bargains.
Other risks include a rise in Asian currencies or trade restrictions that would make imports more expensive, or higher
cotton prices, which could crimp margins. JCP and other retailers could also be vulnerable if Congress imposes taxes or denies
expense reductions on imported goods. The company also faces risks from underinvestment in its e-commerce business, including
systems to safeguard customer data.
Because of its weak financial position, JCP may find it difficult to close or reposition underperforming stores, and may
be forced to take impairment charges.
COMPANY DESCRIPTION
Based in Plano, Texas, J.C. Penney Company Inc. is the holding company for J.C. Penney Corp. The company operated
875 namesake department stores in the U.S. states and Puerto Rico. JCP also sells products through its website (jcpenney.com).
VALUATION
JCP is trading at 18.4-times our FY19 EPS estimate, below the peer average of 27.1 and near the midpoint of the five-
year average annual range of 6.5-31.8. The price/sales multiple is 0.1, below the peer average of 0.2 and at the low end of the five-
year range of 0.1-0.4. The price/book ratio of 0.7 is below the peer average of 2.5 and toward the low end of the five-year range
of 0.5-2.9.
Although the company is taking steps to restructure its merchandise assortment, close underperforming stores, and
bolster its Omnichannel business, we remain concerned about the impact of weak mall traffic and increased competition in the
department store sector. We expect continued weak sales and earnings over the next two years, and with the stock trading below
$4, we believe that it could face additional downward pressure in the near term.
On March 9, HOLD-rated JCP closed at $3.27, down $0.05. (Deborah Ciervo, CFA, 3/9/18)

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