TEXT-S&P cuts J.C. Penney ratings on weak results
Overview -- U.S. retailer J.C. Penney Co. Inc.'s third-quarter and year-to-date results remain extremely weak. -- Credit metrics have deteriorated substantially and we believe that they could erode further over the next few quarters. -- We are lowering the corporate credit rating to 'B-' from 'B+'. -- The stable outlook reflects our view that although performance may weaken further over the next 12 months, we believe that liquidity will remain "adequate." Rating Action On Nov. 9, 2012, Standard & Poor's Ratings Services lowered its corporate credit rating on Plano, Texas-based J.C. Penney Co. Inc. to 'B-' from 'B+'. The outlook is stable. At the same time, we lowered the issue-level rating on the company's unsecured debt to 'B-' from 'B+' and maintained our '3' recovery rating, indicating our expectation for meaningful (50% to 70%) recovery in the event of payment default. Rationale The downgrade reflects recent performance that has remained poor and our view that it will continue to be weak over the next 12 months. Credit protection measures have eroded meaningfully because of the company's decline in EBITDA, and we expect that they could deteriorate further over the next year. It also incorporates our belief that the company is likely to experience further operational disruptions over the next several quarters as it implements its new pricing and merchandising strategy. The ratings on Penney reflect Standard & Poor's assessment that the company's business risk profile is "vulnerable" and its financial risk profile is "highly leveraged." Our business risk assessment incorporates our analysis that the department store industry is highly competitive with large, well-established participants. Based on this environment, it is our view that further performance difficulties may result in the loss of market share to other players, such as Macy's, Kohl's, Dillard's, or other department stores or specialty retailers. Performance remained extremely weak in the third quarter with same-store sales down 26.1%. EBITDA margins dropped to 2.9% at Oct. 27, 2012, compared with 9.5% for the prior period in 2011, resulting in a 75% decline in EBITDA year over year. Over the next 12 months, we expect Penney will experience further operational disruptions as it implements the new strategy. We believe that customer traffic is likely to remain negative, thus resulting in weaker revenue performance and resulting in additional markdowns. Our assumptions for the company for 2012 include: -- Sales per square foot to decline in the low-20% area; -- EBITDA margins to remain in the 2% area as markdowns and negative operating leverage offset benefits from cost reductions; -- Capital expenditures to be about $800 million; and -- No share repurchases. We assess Penney's financial risk profile as highly leveraged as credit protection measures have deteriorated over the past year because of performance declines. Debt to EBITDA increased to about 12x at Oct 27, 2012 from 2.9x for the prior period in 2011. Interest coverage fell to 1.2x from 4.7x and funds from operations (FFO) to total debt slid to (2.6%) from 30.8% period over period. We expect that credit protection measures are likely to remain in line with current levels over the next 12 months. Liquidity We assess Penney's liquidity as "adequate" with sources of cash likely to exceed uses for the next 12 to 24 months. Cash sources include about $525 million of cash on hand and $1.5 billion available under its credit facility and some modest reduction of working capital. The company converted its revolving credit facility from an unsecured basis to a borrowing base facility in January 2012 and increased the amount to $1.5 billion in February 2012. We anticipate cash uses of $800 million in capital expenditures, resulting in negative free operating cash flow of about $350 million for the year. Other relevant aspects of the company's liquidity are as follows: -- Coverage of liquidity sources over uses, which we estimate to be above 1.2x; -- Net liquidity sources that we expect would be positive, even with a 15% decline in EBITDA; -- Well-established and solid relationships with its banks; and -- Manageable debt maturities over the next two to three years. Recovery analysis Our issue-level rating on Penney is 'B-', with a '3' recovery rating, indicating our expectation for meaningful (50% to 70%) recovery in the event of payment default. Outlook The stable rating reflects our view that further operational issues are likely over the next year, but that liquidity will remain adequate. We anticipate the weak operational performance will result in the erosion of already very weak credit protection measures. Although we don't consider an upgrade likely at this point, key positives would include performance recovery much earlier than we expect with no further meaningful changes in the management team. Any consideration for an upgrade would require leverage below 6.0x and coverage above 2.0x. We could consider lowering our rating if performance weakened considerably and we revised our assessment of the company's liquidity. Under this scenario, same-store sales would remain in the negative mid- to upper-20% range and margins would decline by about 100 basis points. At that time, interest coverage would be meaningfully below 1.0x and the company would begin to fund operations with availability under its credit facility. Additionally, any meaningful share repurchases over the near term could have a negative effect on the rating or outlook. Related Criteria And Research -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Use Of CreditWatch And Outlooks, Sept. 14, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Downgraded; Recovery Rating Unchanged; Outlook Action To From J.C. Penney Co. Inc. Corporate Credit Rating B-/Stable/-- B+/Negative/-- J.C. Penney Co. Inc. J.C. Penney Corp. Inc. Senior Unsecured B- B+ Recovery Rating 3 3 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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