Fitch Discusses Spiking J.C. Penney (JCP) CDS Spreads
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Significant widening in J.C. Penney's (NYSE: JCP) five-year credit default swap (CDS) spreads underscores continued investor concern as the retailer struggles to find its footing, according to Fitch Solutions. Earlier this week, the company scaled back its partnership with Martha Stewart Living Omnimedia and last week denied rumors of bankruptcy.
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. We note that volatility across the board in CDS trading is common.
Fitch downgraded J.C. Penney Co., Inc.'s and J.C. Penney Corporation, Inc.'s issuer default ratings to 'CCC' from 'B-' on Oct. 2, which reflected higher than expected cash burn in 2013 and Fitch's concern that the projected free cash flow (FCF) shortfall in 2014 will require additional external funding, even with an over $3 billion liquidity injection so far this year (and a $850 million draw on its revolver).
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.
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. We note that volatility across the board in CDS trading is common.
Fitch downgraded J.C. Penney Co., Inc.'s and J.C. Penney Corporation, Inc.'s issuer default ratings to 'CCC' from 'B-' on Oct. 2, which reflected higher than expected cash burn in 2013 and Fitch's concern that the projected free cash flow (FCF) shortfall in 2014 will require additional external funding, even with an over $3 billion liquidity injection so far this year (and a $850 million draw on its revolver).
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.
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