Fitch Ratings has affirmed the Issuer Default Ratings (IDRs) of J.C. Penney Co., Inc. and J.C. Penney Corporation, Inc. at ‘CCC’. The Rating Outlook is Positive. A full list of rating actions follows at the end of this press release.
KEY RATING DRIVERS
Fitch Ratings expects J.C. Penney to generate EBITDA of approximately $600 million in 2015 versus $277 million in 2014, based on 3% comparable store sales (comps) growth, gross margin of approximately 36%, and further selling, general and administrative (SG&A) reduction of approximately $100 million. The Positive Outlook reflects the potential that J.C. Penney could generate annual EBITDA in the $700 million to $800 million range in 2016 and 2017, which would cover its fixed obligations, and the company makes progress in addressing its debt maturities through 2018.
Fitch expects J.C. Penney to sustain comps growth in the 2%-3% range and gross margin to improve modestly beyond 2015. This should result in EBITDA of approximately $700 million in 2016, with the potential to approach $800 million in 2017, assuming flat SG&A expense.
On its recent first-quarter earnings call, J.C. Penney reiterated its targets to reach a top-line of $14.5 billion and EBITDA of $1.2 billion by 2017, by rebuilding market share on its existing platform and investing in growth initiatives in center core (fine jewelry and fashion accessories, Sephora, footwear, handbags and intimate apparel), home and omnichannel.
While targeted 2017 revenue of $14.5 billion would still be 15% shy of 2011 levels of $17.3 billion, Fitch views the 5%-6% in annual revenue growth required in 2016 and 2017 to achieve this target as ambitious given today’s industry dynamics. Fitch expects overall apparel, accessories, footwear and home sales to grow 2%-3% annually, with growth in online sales accounting for over 50% of the growth. Department store traffic trends remain soft and industry sales are expected to continue to decline 2% annually as volume continues to shift to off-mall channels, such as online, discount and off-price retailers.
Overall share gains in the overcrowded mid-tier space will therefore remain challenging, and Fitch expects 2%-3% annual comps growth is sustainable at best. Fitch anticipated J.C. Penney’s store traffic to be flat to modestly up over the next 12-24 months, with store-level comps up 1%-2%. Fitch expects online sales to grow 10%-12% annually from the 2014 base of $1.2 billion, to $1.6 billion-$1.7 billion in 2017, contributing 1.0%-1.3% annually to overall comps.
The company ended 2014 with $2.1 billion in liquidity between cash and cash equivalents of $1.3 billion and $773 million available under its $1.85 billion credit facility. Free cash flow (FCF) in 2014 was a modest negative $13 million compared to negative $2.8 billion in 2013, reflecting EBITDA growth and working capital improvement to positive $332 million. FCF is expected to be flat to negative $100 million in 2015, assuming cash interest expense of $400 million, capex of $250 million-$300 million and flat to modest working capital use.
The company’s next debt maturity is $78 million in August 2016 and $220 million in April 2017. These could be refinanced or partly paid down with cash.
— Fitch expects J.C. Penney to generate positive EBITDA of $600 million in 2015, based on 3% comps growth, gross margin of approximately 36%, and further SG&A reduction of approximately $100 million.
–EBITDA in 2016 and 2017 could improve by another $100 million annually assuming J.C. Penney sustains low single comps, modest improvement in gross margin, and flat SG&A.
— FCF is expected to be flat to negative $100 million in 2015, assuming cash interest expense of $400 million, capex of $250 million-$300 million and flat to modest working capital use.
— Liquidity is expected to remain strong at around $2 billion at the end of 2015.
Positive Rating Action: A positive rating action could occur if the continues to generate 2%-3% comp growth and EBITDA in the $700 million to $800 million range to cover its fixed obligations and has sufficient liquidity to address near term debt maturities on a timely basis.
Negative Rating Action: A negative rating action could occur if comps and margin trends stall, indicating J.C. Penney is not stabilizing its core business, leading to concerns about the company’s liquidity position.
ISSUE RATINGS BASED ON RECOVERY ANALYSIS
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 (RR) and notching, based on Fitch’s recovery analysis that places a liquidation value under a distressed scenario of approximately $5.5 billion as of Jan. 31, 2015, for J.C. Penney.
J.C. Penney’s $2.35 billion senior secured asset-backed loan (ABL) facility that matures in June 2019 is rated ‘B/RR1’, which indicates outstanding recovery prospects (91%-100%) in a distressed scenario. The facility comprises a $1.85 billion revolving line of credit and a $500 million first-in, last-out term loan.
The facility is secured by a first lien priority on inventory and receivables with borrowings subject to a borrowing base. Any proceeds of the collateral will be applied first to the satisfaction of all obligations under the revolving facility and second to the satisfaction of the obligations under the term loan facility.
J.C. Penney is required to maintain a minimum excess availability at all times of not less than the greater of 10% of line cap (the lesser of total commitment or borrowing base) and $150 million.
The $2.2 billion term loan due May 2018 is also expected to have outstanding recovery prospects of 91%-100%, leading to a ‘B/RR1’ rating. The term loan facility is secured by (a) first lien mortgages on owned and ground leased stores (subject to certain restrictions primarily related to Principal Property owned by J.C. Penney Corporation, Inc.), the company’s headquarters and related land, and nine owned distribution centers; (b) a first lien on intellectual property (trademarks including J.C. Penney, Liz Claiborne, St. John’s Bay and Arizona), machinery and equipment; (c) a stock pledge of J.C. Penney Corporation and all of its material subsidiaries and all intercompany debt; and (d) second lien on inventory and accounts receivable that back the ABL facility.