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
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.
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
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