Moody's Cuts JCPenney's (JCP) CFR, L-T Ratings from Ba3 to B3, Outlook Negative

November 20, 2012 2:31 PM EST
Moody's Investors Service today downgraded J.C. Penney Company, Inc.'s ( NYSE: JCP) long term ratings, including its Corporate Family Rating and Probability of Default Rating to B3. At the same time, Moody's also downgraded J.C. Penney's Speculative Grade Liquidity rating to SGL-3 which represents adequate liquidity. The rating outlook is negative.

The following ratings are downgraded

For J.C. Penney Company, Inc.

Corporate Family Rating to B3 from Ba3

Probability of Default Rating to B3 from Ba3

Speculative Grade Liquidity rating to SGL-3 from SGL-1

For J.C. Penney Corporation, Inc.

Senior unsecured notes to Caa1 (LGD 4, 66%) from Ba3 (LGD 4, 59%)

Senior unsecured shelf to (P) Caa1 from (P) Ba3


The downgrade of the Corporate Family Rating and Probability of Default rating reflects Moody's expectation that JCP's fourth quarter gross margins will severely decline as a result of the need to actively clear excess inventory. This, when combined with continued sizable sale declines in the fourth quarter, will lead to earnings and credit metrics bottoming out at levels significantly weaker than expected. Thus, Moody's no longer believes that credit metrics will return to being supportive of a Ba3 rating over the next twelve months. Moody's currently estimates that JCP's credit metrics will fall to levels indicative of a Ca rating for fiscal year 2012.

The downgrade of the Speculative Grade Liquidity to SGL-3 from SGL-1 reflects Moody's estimate of increased cash burn over prior estimates and our belief that JCP will need to draw down its cash balances in 2013 to finance the capital required for the new shops. This will require JCP to temporarily use its revolving credit facility over the next twelve months to fund capital expenditures and interim working capital needs.

JCP recently announced third quarter results which were significantly worse than Moody's expectations of a -20% decline. JCP's third quarter sales results indicated an acceleration in the pace of decline to a -26.1% comparable store sales decline compared to -21.7% in the second quarter. In addition, EBIT also declined significantly in the second quarter to $(268) million compared to $120 million last year.

The B3 rating reflects JCP's very poor credit metrics, significant level of operating losses, and projected level of free cash flow burn. It also reflects that sales will contract further resulting in additional erosion in earnings and credit metrics by the end of 2012. The rating is supported by JCP's adequate liquidity from its $525 million in cash at October 27, 2012 and a $1.5 billion undrawn asset based revolving credit facility expiring July 2016. It also reflects that JCP's nearest debt maturity is not until 2015 when its $200 million 6.875% medium term notes mature. JCP's adequate liquidity and lack of near dated debt maturities provide it with the flexibility to develop a strategy to abate the sizable declines in both sales and gross margins while rolling out its new shops concept. Moody's also believes that JCP's unencumbered assets provide it with additional financial flexibility.

Moody's continues to believe that the new shops are compelling and the sales per square foot generated during the third quarter provide a hopeful data point. However, the new shops only comprise about 11% of JCP selling space and it will take JCP another year to bring the new shops up to 40% of its selling space. In addition, it is currently unclear how JCP will bring back customer traffic and drive sales in the "heritage" JCP square footage.

The B3 rating balances the near term significant weakness in JCP's profitability and credit metrics against a longer term view that ultimately its shops concept and revitalized merchandise will drive higher gross margins increasing profitability such that credit metrics will improve back to levels supportive of a B3 level. Moody's notes that JCP debt to EBITDA at October 27, 2012 was 8.0 times and EBITA to interest expense was 0.0 times, both levels are more indicative of a Ca rating. Moody's anticipates that credit metrics will erode further from these levels but that the erosion will be temporary.

The negative outlook indicates Moody's concern that JCP earnings and free cash flow may decline further than currently anticipated. The negative outlook also reflects the risk that JCP could increase its reliance on its revolving credit facilities.

Ratings could be downgraded should the rate of JCP's sales decline accelerate above the third quarter rate in the fourth quarter of 2012. Ratings could also be downgraded should the sales decline not abate once JCP anniversaries the launch of its new pricing strategy in the first quarter of 2013 or should gross margins not begin to recover in the first quarter of 2013. Quantitatively ratings could be downgraded should it become likely that debt to EBITDA will remain sustained above 8.0 times over the longer term.

Given the negative outlook, it is unlikely that ratings will be upgraded over the near term. However, ratings could be upgraded should operating performance improve such that sales begin to grow while achieving a 36% gross margin and debt to EBITDA is likely to remain sustained below 7.0 times. The rating outlook could return to stable should JCP's sales and gross margins stabilize.

The principal methodology used in rating J.C. Penney Company, Inc was the Global Retail Industry Methodology published in June 2011. Other methodologies used include Loss Given Default for Speculative-Grade Non-Financial Companies in the U.S., Canada and EMEA published in June

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