November 9, 2012 / 9:55 PM / 5 years ago

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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