S&P Lifts Outlook on JCPenney (JCP) to Positive; Sees 'Modest Gains' Over Next Year

Summary:

• J.C. Penney Co. Inc.'s turnaround efforts have returned comparable-store sales, margins, and EBITDA to positive territory while reducing cash burn and we believe this will continue.
• We are revising our outlook to positive from stable, reflecting our view that there is a one-third chance over the next year or so that further successful execution of the merchandising turnaround, reduced cash burn, and EBITDA growth will result in a capital structure we believe is sustainable, leading to a modest upgrade.
• At the same time, we are affirming all ratings on the company, including the 'CCC+' corporate credit rating.

Standard & Poor's Ratings Services today revised its outlook on JCPenney (NYSE: JCP) to positive from stable. At the same time, we affirmed all ratings, including the 'CCC+' corporate credit rating, on the company.

"The outlook revision reflects our forecast for further modest gains over the next year. We think there is a one-third chance that adjusted EBITDA will approach around $1 billion, which is one indication that the company's capital structure would be sustainable," said credit analyst Robert Schulz. "Other metrics supporting an upgrade would include prospects for breakeven or better cash flow after capital spending of at least $250 million, prospects for further meaningful reductions in legacy selling, general, and administrative (SG&A) cost levels, and success in online initiatives and the home furnishings segment (both of which would be reflected in revenue growth)."

The positive outlook reflects our view that there is a one-third chance over the next year or so that further successful execution of the merchandising turnaround, reduced cash burn, and EBITDA growth will result in a sustainable capital structure, leading to an upgrade.

We could consider lowering our rating if the company's performance gains reverse because of merchandise missteps or an unexpected erosion of consumer spending leading to a return to significant cash use. Under this scenario, we believe the company could likely default within a 12-month period. In such a scenario, the company is unable to stabilize operations, returning to cash burn in the range of around $750 million. Additional financing options would narrow and vendors would tighten turns leading to a substantial decline in cash on hand.

We could raise the rating if adjusted EBITDA seems capable of reaching around $1 billion versus our base-case forecast of about $800 million in 2015. For example, we estimate sales growth of more than 2% and EBITDA margins in the high-7% area would generate EBITDA in that range. Other supporting metrics for an upgrade would include prospects for positive cash flow after capital spending, prospects for ongoing meaningful reductions in SG&A spending and success in online and the home furnishings segment (which would be reflected in sales growth). This scenario would likely necessitate overall revenue growth closer to the level of same-store sales of around 3% and reduction in the still high legacy levels of SG&A. Consideration for an upgrade would require prospects for sustained leverage below 7.0x along with interest coverage above 1.5x. Such improvements in sales growth and margins would also cause us to view the company's business risk more favorably.

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