TEXT-Fitch cuts J.C. Penney's IDR to 'B-'
Feb 28 - Fitch Ratings has downgraded the Issuer Default Ratings (IDRs) on J.C. Penney Co., Inc. and J.C. Penney Corporation, Inc. to 'B-' from 'B'. The Rating Outlook is Negative. A full list of rating actions follows at the end of this press release. KEY RATING DRIVERS The rating downgrades reflect Fitch's concerns that there is a lack of visibility in terms of the company's ability to stabilize its business in 2013 and beyond after a precipitous decline in revenues leading to negative EBITDA of $270 million in 2012 (this figure excludes noncash pension expense, stock-based compensation, and restructuring charges). J.C. Penney will need to tap into additional funding to cover a projected FCF shortfall of $1.3 billion - $1.5 billion in 2013, which could begin to strain its existing sources of liquidity. J.C. Penney's 25.2% decline in comparable store sales (comps) in 2012 reflects the challenges of moving toward a more everyday value strategy with significantly reduced promotions. The jury remains out on whether J.C. Penney has done some irrevocable damage or whether it can begin to stabilize its core revenue base and sustainably improve profitability of its business beginning the first quarter of 2013. It remains unclear whether the new shops and merchandise offerings can offset any continued declines in the non-shops business, which currently accounts for 92% of its square footage, in the second-half 2013. Fitch expects that sales trends could remain in the negative low single digit range in 2013, with gross margin in the mid-30 percentage range relative to 32.5% for 2012. (This is still well below the 39% - 40% range the company should realize if inventory is appropriately aligned to sales expectations.) This would result in EBITDA of $150 million - $200 million, well below the minimum $1.2 billion - $1.3 billion levels needed to be FCF neutral. More negative assumptions, including sales declines in the mid-single digit range with the gross margin at 2012 levels would result in negative EBITDA of over $300 million. On the upside, however, a stabilization in sales trends and the gross margin recovering strongly to the 38 - 39% range could see EBITDA improve to the positive $600 million to $700 million. First quarter 2013 results will provide a first glimpse at where underlying sales start levelling off. The company would have to generate EBITDA of $1.2 billion - $1.3 billion to fund interest expense of $250 million and higher capex needs to support accelerated shop roll-outs in 2013 to be FCF even, assuming no adverse swings in working capital. This would require a comps increase of 10% and gross margins to return to 39% - 40%, which Fitch views as a highly unlikely scenario. J.C. Penney ended 2012 with $930 million in cash and $1.2 billion available on its recently upsized $1.85 billion revolver. Free cash flow (after dividend) was negative $906 million, in spite of working capital being a more than $700 million source of cash (mostly on inventory reduction and improved vendor payables). Free cash flow is projected at negative $1.3 billion - $1.5 billion in 2013, and is expected to remain materially negative in 2014 based on current projected EBITDA levels and higher capex needs. As a result, Fitch expects the company will have to start drawing down on its revolver and look to other financing sources (secured, convertible debt or preferred shares) to fund operations and peak seasonal working capital needs. Under its newly amended facility, J.C. Penney is permitted to issue up to $1.75 billion in debt to be secured by a second lien on the ABL collateral and a first lien on other assets. The company owns 426 stores (including 121 located on ground leases), 12.2 million square feet of distribution center, regional warehouse and fulfillment center space, and its Plano Texas headquarters with 240 acres (or 10.5 million square feet) of adjacent land which are all currently unencumbered. To the extent that the 1982 indenture governing the 7.125% debentures due 2023 (under which the company has to maintain a ratio of net tangible assets to senior funded indebtedness of 2.0x and above) proves to be too restrictive, JCP could potentially use any new debt proceeds to repay the $255 million in outstanding debt under this indenture. The company has no debt maturities prior to October 2015 (and maturities between 2015 and 2018 are $200 million - $300 million annually). J.C. Penney's pension fund remains well funded, and Fitch does not expect the company will need to make any cash contributions in 2013. For issuers with IDRs at 'B+' and below, Fitch performs a recovery analysis for each class of obligations of the issuer. The issue ratings are derived from the IDR and the relevant Recovery Rating and notching, based on Fitch's recovery analysis that places a liquidation value under a distressed scenario of approximately $4.4 billion as of Feb. 2, 2013 for J.C. Penney. J.C. Penney's senior secured credit facility that matures in April 2016, which the company recently upsized to $1.85 billion from $1.5 billion, is rated 'BB-/RR1', indicating outstanding recovery prospects (91% - 100%) in a distressed scenario. The facility is secured by inventory and receivables with borrowings subject to a borrowing base. The company is subject to a springing covenant of maintaining a fixed charge coverage of 1.0x-1.1x if availability falls below a certain threshold or the company undertakes certain actions such as making restricted payments. The $2.9 billion senior unsecured notes and debentures have been downgraded to 'B-/RR4' from 'BB-/RR2', indicating average recovery prospects (31% - 50%). The lowered ratings on the notes reflect Fitch's expectation that the company will need to incur additional secured debt to fund operations in the near term, which would jeopardize the longer-term recovery prospects of the unsecured notes. RATING SENSITIVITIES A negative rating action could occur if comps and margin trends continue to erode, indicating J.C Penney is not stabilizing its core business, leading to concerns around the company's liquidity position. A Positive Rating action could occur if top line starts to stabilize and the company realizes more normalized gross margin levels. Leverage would need to be closer to 6x which on current debt levels would imply EBITDA of around $625 million. Fitch has downgraded the ratings on J.C. Penney as follows: J.C. Penney Co., Inc. --IDR to 'B-' from 'B'. J.C. Penney Corporation, Inc. --IDR to 'B-' from 'B'; --$1.85 billion senior secured bank credit facility to 'BB-/RR1' from 'BB/RR1''; --$2.9 billion senior unsecured notes and debentures to 'B-/RR4' from ''BB-/RR2'. The Rating Outlook is Negative. Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings. Applicable Criteria and Related Research: --'Corporate Rating Methodology' (Aug. 8, 2012); --'Evaluating Corporate Governance' (Dec. 12, 2012). Applicable Criteria and Related Research Corporate Rating Methodology Evaluating Corporate Governance