TEXT-Fitch revises J.C. Penney rating outlook
June 6 - Fitch Ratings has affirmed its Issuer Default Rating (IDR) on J.C. Penney Co., Inc. and J.C. Penney Corporation, Inc. at 'BB+' but revised the Rating Outlook to Negative from Stable. A full list of rating actions appears at the end of this press release. The ratings reflect significant execution risk for J.C. Penney over the next 12-18 months given the company's new pricing and promotional strategy and its attempt to address fundamental areas such as merchandising, costs, and investments in its store base. The company should be able to take costs out of the system given a bloated expense structure to fund the much needed investments in its physical store base. However, the jury remains out on whether consumers will buy into the new merchandising and pricing structure to enable J.C. Penney to turn around faltering sales and sustainably improve the profitability of its business once it gets through this transformational year. The revision in the Outlook reflects worse than expected first-quarter performance, highlighting the significant deterioration in traffic as J.C. Penney moves toward a more everyday value strategy with significantly reduced promotions, a marked departure from the industry's high-low promotional strategy. The cash burn was also disappointing although the company still has adequate liquidity to fund its investments (including an undrawn $1.5 billion credit facility) and could potentially see improvement in working capital. The accelerated expense reduction (with $900 million in cost savings expected this year versus 2013), the dividend cut, and the potential to monetize non-core assets should support the company's liquidity position. Fitch now believes that the top line could contract in the low double-digit range versus its prior expectation of a high single-digit range decline in 2012. In addition, sales could be disrupted by clearing out any excess merchandise as the company continues to adjust inventory levels and by remodeling activity related to rolling out the 'store-within-a-store' initiative at the beginning of second half 2012. Fitch expects gross margin in 2012 will be flat to 2011 levels (estimated at around 37% of sales excluding any one-time charges, the lowest level over the last decade, versus an average of 39% between 2005 and 2010), and selling, general and administrative expense (SG&A) to decline over 10% in dollar terms. As a result, 2012 EBITDA is expected to be $1.1 billion to $1.2 billion and leverage is expected to be in the high 3.0x level (these figures exclude non-cash pension expense, stock-based compensation and restructuring charges). J.C. Penney would have to show sequential improvement in sales, margin rate and cash flow generation over the remainder of 2012 and leverage would have to remain well within 4.0x in 2013 in order to maintain current rating levels. Fitch has affirmed the ratings on J.C. Penney as follows: J.C. Penney Co., Inc. --IDR at 'BB+'. J.C. Penney Corporation, Inc. --IDR at 'BB+'; --$1.5 billion senior secured bank credit facility at 'BBB-'; --$3.1 billion senior unsecured notes and debentures at 'BB+'. The Rating Outlook is Negative.
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