Fitch Downgrades J.C. Penney (JCP) IDRs to CCC
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Fitch Ratings has downgraded the Issuer Default Ratings (IDRs) on J.C. Penney Co., Inc. and J.C. Penney Corporation, Inc. (NYSE: JCP) to 'CCC' from 'B-
KEY RATING DRIVERS
Higher than expected cash burn in 2013: The rating downgrades reflect higher than expected cash burn in 2013 and Fitch's concern that the projected FCF shortfall in 2014 will require additional external funding, even with $3-plus 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 billion to negative $1.2 billion (versus prior projections of negative $0.5 billion) and higher than expected working capital use in excess of $0.5 billion.
The revised EBITDA reflects weaker-than-expected comp store sales (comps), particularly in the new home categories and back-to-school categories, and the subsequent markdown of excess inventory leading to significant gross margin contraction. The higher working capital use reflect the significant inventory build-up related to the new home departments and upcoming launches such as Disney, as well as the buildup related to bringing back some of the private label brands (St. John's Bay, Ambrielle, Cooks) and basics that were significantly cut back last year under Ron Johnson. Fitch believes the risk for further inventory markdown remains through the holiday season as inventory buys remain aggressive and sales could continue to disappoint.
Equity infusion offsets higher cash burn: With the additional liquidity injection of approximately $800 million (or approximately $900 million if the underwriter exercises its option in full) from the recent equity offering on top of the $2.25 billion secured term loan issued in May, Fitch expects total year end liquidity to be around $2.0 to $2.1 billion (with $300 million available on its $1.85 billion credit facility assuming no change in the current $850 million outstanding and $500 million in letters of credit), allaying near-term concerns from the vendor community.
However, additional external funding may be needed in 2014. 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 to $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 to $13.6 billion - 14% to 16% above 2013 projected levels - and realize gross margins in the 39%-40% range, assuming a relatively flat cost structure.
This 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 first half 2013 (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.
Therefore, FCF is still expected to be materially negative in 2014. Cash burn could be as high as $1 billion next year if EBITDA is still modestly negative which could necessitate additional external funding for the 2014 holiday season. Peak seasonal working capital funding needs (from year end levels which are typically used as a gauge of trough working capital levels) are estimated to be $850 million to $1 billion. The speed and ability of the company to return to positive comps growth and sell at more normalized gross margins (in the 38% to 40% range assuming inventory buys are aligned with sales expectations) will ultimately determine additional funding requirements in 2014 and beyond.
KEY RATING DRIVERS
Higher than expected cash burn in 2013: The rating downgrades reflect higher than expected cash burn in 2013 and Fitch's concern that the projected FCF shortfall in 2014 will require additional external funding, even with $3-plus 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 billion to negative $1.2 billion (versus prior projections of negative $0.5 billion) and higher than expected working capital use in excess of $0.5 billion.
The revised EBITDA reflects weaker-than-expected comp store sales (comps), particularly in the new home categories and back-to-school categories, and the subsequent markdown of excess inventory leading to significant gross margin contraction. The higher working capital use reflect the significant inventory build-up related to the new home departments and upcoming launches such as Disney, as well as the buildup related to bringing back some of the private label brands (St. John's Bay, Ambrielle, Cooks) and basics that were significantly cut back last year under Ron Johnson. Fitch believes the risk for further inventory markdown remains through the holiday season as inventory buys remain aggressive and sales could continue to disappoint.
Equity infusion offsets higher cash burn: With the additional liquidity injection of approximately $800 million (or approximately $900 million if the underwriter exercises its option in full) from the recent equity offering on top of the $2.25 billion secured term loan issued in May, Fitch expects total year end liquidity to be around $2.0 to $2.1 billion (with $300 million available on its $1.85 billion credit facility assuming no change in the current $850 million outstanding and $500 million in letters of credit), allaying near-term concerns from the vendor community.
However, additional external funding may be needed in 2014. 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 to $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 to $13.6 billion - 14% to 16% above 2013 projected levels - and realize gross margins in the 39%-40% range, assuming a relatively flat cost structure.
This 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 first half 2013 (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.
Therefore, FCF is still expected to be materially negative in 2014. Cash burn could be as high as $1 billion next year if EBITDA is still modestly negative which could necessitate additional external funding for the 2014 holiday season. Peak seasonal working capital funding needs (from year end levels which are typically used as a gauge of trough working capital levels) are estimated to be $850 million to $1 billion. The speed and ability of the company to return to positive comps growth and sell at more normalized gross margins (in the 38% to 40% range assuming inventory buys are aligned with sales expectations) will ultimately determine additional funding requirements in 2014 and beyond.
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