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Fitch Rates J.C. Penney’s New $1.75B Term Loan ’BB-/RR1’; Outlook Negative

May 01, 2013, 07:03 AM
Filed Under: Corporate Ratings

Fitch Ratings has assigned a 'BB-/RR1' rating to J.C. Penney's new five-year $1.75 billion senior secured term loan facility. The closing of the new facility is contingent upon the successful tendering or defeasance (of at least two-thirds of the amount outstanding) of the $225 million in debentures due 2023. In addition, Fitch has affirmed its Issuer Default Ratings (IDRs) on J.C. Penney Co., Inc. and J.C. Penney Corporation, Inc. at 'B-'. The Rating Outlook is Negative.

Key Rating Drivers

The new $1.75 billion term loan facility will be 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.) with an aggregate value of not less than $400 million, the company's headquarters and related land, and nine owned distribution centers; (b) a first lien on intellectual property, 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 $1.85 billion asset-backed (ABL) facility.

The proceeds of the term loan will be used to fund operations, working capital, and capital expenditures and to amend, acquire or satisfy and discharge the company's $255 million outstanding 7 1/8% debentures due 2023 to get rid of all restrictive covenants. The terms of these debentures required the company to maintain a ratio of net tangible assets to senior funded indebtedness of 2.0x and above (under which it could have only incurred $1.4 billion in debt at the end of 2012), which would have proven to be too restrictive. Defeasance or tendering of the debentures also removes any restrictions on its ability to draw on its $1.85 billion credit facility as a long-term debt source.

The financing maxes out the incremental amount of first- and second-lien debt JCP can incur, although it could issue unsecured, subordinated debt, convertible notes or preferred equity.

Fitch views the injection of additional capital as a positive to fund operations in 2013 given a projected cash burn of $1.7 billion-$1.9 billion. Fitch currently assumes EBITDA of negative $500 million on top-line contraction in the high single digits, $800 million in capital expenditures (substantially similar to 2012 levels) and potential working capital use of $200 million to $300 million. In addition, the company has to fund the defeasance or tendering of the 2023 debentures.

Beyond 2013, Fitch estimates that the company will have to generate a minimum of $750 million to $900 million in EBITDA to fund ongoing capital expenditures 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 $14 billion, or 8% above 2012 levels, and realize gross margins in the 39%-40% range given the current cost structure, and some expected incremental investments in areas such as advertising and marketing to prop up sales via a return to a high-low pricing strategy.

This appears to be an ambitious level and therefore, free cash flow is still expected to be materially negative in 2014. However, the reintroduction of coupons which is underway, the imminent completion of the very extensive and disruptive home furnishings makeover, the return of critical brands such as St. John's Bay (which Fitch estimates used to generate in excess of $1 billion of sales but was eliminated in major categories), and the addition of new brands should stem the pace of decline in the business as incurred in 2012 and expected in first quarter 2013. The speed and ability of the company to stabilize sales and return to positive comparable store sales growth will determine additional funding requirements in 2014 and beyond. As of now, Fitch expects liquidity, between the new term loan and the $1.85 billion credit facility, to be adequate through 2014.

View the entire Fitch Ratings press release here.

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