JC Penney: Fitch Rating Sees “Highly Ambitious” Scenario

Poor J.C. Penney (JCP). The struggling retailer started off the day in positive territory. Then word spread of an Fitch Ratings report on its finances pegged to signs of stress in J.C. Penney’s credit-default swaps, sending shares tumbling.

REUTERS

Here’s what Fitch had to say:

JCP CDS spiked more than 300 basis points over the course of the last week and are now trading at record wide levels, according to Fitch Solutions. The sharp rise in cost to protect JCP’s five-year senior bonds indicates that investors suspect a higher risk of default…

Fitch now projects cash burn of $2.8 billion-$3.0 billion in 2013, a billion dollars higher than its mid May projections. This reflects EBITDA of negative $1.0 billion-$1.2 billion (versus prior projections of negative $0.5 billion) and higher than expected working capital use in excess of $0.5 billion.

Beyond 2013, Fitch estimates that the company will have to generate a minimum of $750 million-$875 million in EBITDA to fund ongoing capex in the $400 million-$500 million range and cash interest expense of $360 million-$375 million. This would require the company to return sales to about $13.4 billion-$13.6 billion — 14%-16% above 2013 projected levels — and realize gross margins in the 39%-40% range, assuming a relatively flat cost structure.

This scenario appears highly ambitious, given the significant execution risk. While the reintroduction of coupons and critical private brands such as St. John’s Bay in major categories should stem the significant pace of decline in the business that occurred in 2012 and 1H13 (top-line decline of 24.8% and 14.2%, respectively), the upfront investments in inventory, capex, and promotional activity are significant and we have yet to see positive traction.

A negative rating action could occur if comps and margin trends continue to erode, indicating that 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 the company generates sufficient EBITDA to cover its projected capex and cash interest expense.

On a relatively quiet day for retailer, shares of J.C. Penney have fallen 3.8% to $6.77, but are still above their recent lows. Kohl's (KSS), meanwhile, has edged up 0.1% to $54.93, Macy's (M) has risen 0.4% to $44.72 and Sears Holdings (SHLD) has gained 0.6% to $55.97.

Correction: In the headline to this post I originally wrote “Ambiguous” instead of “Ambitious.” It’s since been corrected.