J.C. Penney (JCP) IDRs Upgraded to 'B' by Fitch; Outlook Positive

Fitch Ratings has upgraded the Issuer Default Ratings (IDRs) of J.C. Penney Co., Inc. and J.C. Penney Corporation, Inc. (NYSE: JCP) to 'B' from 'B-'. The Rating Outlook is Positive. A full list of rating actions follows at the end of this press release.

KEY RATING DRIVERS
Pathway to $1 billion EBITDA: J.C. Penney Company, Inc. (J.C. Penney) has demonstrated a meaningful turnaround in its business over the last two years and Fitch expects the company to generate EBITDA of approximately $950 million in 2016 (which adds back approximately $45 million in non-cash stock-based comp) versus a better than expected $750 million in 2015. There is good visibility on J.C. Penney's ability to improve EBITDA to $1 billion-plus in 2017 unless the recent weakness in industry apparel sales persists and hurts J.C. Penney's recovery.

Sustainable Low Single-Digit Comps: Fitch expects J.C. Penney to sustain comparable store sales (comps) growth, including online growth, in the 2%-3% range in 2016/2017, as it invests in areas such as Sephora, home-related categories, private brands and omnichannel.

Underlying our comp assumption is the expectation that industry apparel, accessories, footwear and home sales grow 2%-3% annually. While online growth (from a 2014 base of $1.2 billion) is expected to contribute at least half of comps growth, modestly positive store sales momentum should occur as the company's square footage productivity continues to rebound from the significant reductions during 2012/2013 due to now-reversed promotional and merchandising changes.

J.C. Penney's ability to sustain 2%-3% positive comps compares favorably to its department store peers - overall 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.

EBITDA Margin Trending Towards 8%: Gross margins have improved 130 bps to 36% in 2015, through improved clearance and promotional-selling margin performance, increased sales of private brands and key value items, and better in-stock positions. The company has been focused on cost-cutting efforts and achieved net SG&A reduction of $218 million in 2015.

Fitch expects gross margin to improve modestly and expects SG&A reduction in the $50 million to $100 million range in 2016 as the company continues to rightsize its cost structure to a $13 billion to $14 billion top-line, relative to $17 billion-plus in 2011. Should these SG&A savings materialize, J.C. Penney's SG&A ratio would return to 33%-33.5%, in line with the 33.3% level in 2011.

As a result of improved gross margin and SG&A reduction on low single-digit top-line growth, Fitch expects EBITDA margin to approach 8% in 2017 from approximately 6% in 2015 - in line with 2011 levels of 7.7%. This is still well below the 12.5%-13% range at some of its peers such as Macys, Kohl's and Nordstrom.

Free Cash Flow Turns Positive: FCF was positive $120 million in 2015, coming in better than our breakeven expectations. Fitch expects FCF to be positive $200 million in 2016 and approach almost $300 million in 2017. (See liquidity section for more detail.)

Leverage Expected to Be Below 6x in 2016: Adjusted debt/EBITDAR was 7x at the end of 2015 and is expected to trend below 6x in 2016 given our projections of approximately $950 million in EBITDA and $400 million in debt paydown.

KEY ASSUMPTIONS
-- Fitch expects J.C. Penney to sustain comps growth in the 2%-3% range in 2016/2017.
-- Adjusted debt/EBITDAR is expected to be below 6x at the end of 2016 and could trend towards 5x in 2017 if EBITDA exceeds $1 billion and with $700 million to $800 million in debt paydown over the next two years.
-- With total liquidity at $2.5 billion at the end of 2015, and FCF expectations of $200 million in 2016 and almost $300 million in 2017, the company can comfortably address total unsecured debt maturities of $600 million through 2018. Asset sales could lead to further debt reduction via the reduction of the outstanding term loan.

RATING SENSITIVITIES
Positive Rating Action: A positive rating action could occur if J.C. Penney continues to generate 2%-3% comps growth and EBITDA improves to the $1 billion-plus range; the company pays down upcoming unsecured debt maturities and refinances its $2.2 billion term loan; and leverage moves under 5.5x.

Negative Rating Action: A negative rating action could occur if comps and margin trends stall, indicating resumption of market share loss and leading to concerns about the company's liquidity position.

LIQUIDITY

Total liquidity (cash and revolver availability) was $2.5 billion at year-end 2015, which should enable J.C. Penney to comfortably address total unsecured debt maturities of $600 million through 2018. J.C. Penney retired $494 million outstanding principal of the term loan due in June 2019 in December.

FCF was positive $120 million in 2015, coming in better than our breakeven expectations. Fitch expects FCF to be positive $200 million in 2016 and approach almost $300 million in 2017.

The company is also pursuing the potential sale and partial leaseback of its home office building in Plano, Texas and could look to monetize other assets such as its 9 distribution centers. J.C. Penney estimates that the home office could garner $200 million to $250 million in proceeds in 2016. Fitch notes that Cushman & Wakefield performed appraisals of J.C. Penney's owned assets in April 2013 and came up with $760 million of total appraised value for the owned distribution centers and the home office.

Fitch expects J.C. Penney to be able to meet its goal of paying down $400 million to $500 million of debt in 2016 (including $78 million of unsecured debentures due August 2016 and a portion of its $2.2 billion term loan facility) if it can monetize some of its assets on top of $200 million in projected FCF. The company continues to evaluate amending and extending its $2.2 billion real estate term loan due May 2018.

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 $5.4 billion as of Jan. 30, 2016 for J.C. Penney.

J.C. Penney's $2.35 billion senior secured asset-backed loan (ABL) facility that matures in June 2019 has been upgraded to 'BB/RR1' from 'BB-/RR1', and is expected to have outstanding recovery prospects (91%-100%) in a distressed scenario. The facility is secured by 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 (a) $200 million in the event that 10% of the line cap (the lesser of total commitments under the credit facility or the borrowing base) is equal to or greater than $200 million or (b) the greater of (i) 10% of line cap and (ii) $150 million in the event that 10% of the line cap is less than $200 million.

The $2.2 billion term loan due May 2018 is also expected to have outstanding recovery prospects of 91%-100%, and has also been upgraded to 'BB/RR1' from 'BB-/RR1'. 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. Fitch expects proceeds from any asset sales such as the company's headquarters would be applied towards paying down this loan.

The $2.6 billion of senior unsecured notes have been upgraded to 'B/RR4' from 'B-/RR4', and are expected to have average recovery prospects (31%-50%).

FULL LIST OF RATING ACTIONS

Fitch has upgraded the following ratings:

J.C. Penney Co., Inc.
--IDR to 'B' from 'B-'.

J.C. Penney Corporation, Inc.
--IDR to 'B' from 'B-'.
--Senior secured bank credit facility to 'BB/RR1' from 'BB-/RR1';
--Senior secured term loan to 'BB/RR1' from 'BB-/RR1'; and
--Senior unsecured notes and debentures to 'B/RR4' from 'B-/RR4'.

The Rating Outlook is Positive.

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