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Is JCP Making a Comeback?

Iconic retailer JC Penney (JCP), global leader in producing news of economic underachievement and intramural drama, is showing some signs of improvement.

The slowdown of same store sales has itself slowed, to about 4 percent. And cyber-sales at is up 19 percent in the third-quarter. Its investors apparently an easily inspired crowd, JCP saw its stock lift 7.4% to $8.24.

CEO Mike Ullman gushed: “Over the last six months, we have made significant strides and are now seeing positive signs in many important areas of the business, in spite of what continues to be a difficult environment for consumers and retailers in general.”

The fulcrum of JCP’s strategic rebound has been the reintroduction of discounts jettisoned by ousted CEO Ron Johnson, and the restocking of familiar in-house brands, like St. John’s Bay, that were pushed aside to focus on bigger ticket, luxury goods.

While Ullman insisted JCO is “making solid progress” he also cautiously acknowledged that the retailer is “still in the early stages of the turnaround.” He continued:  “Over the last six months, we have made significant strides and are now seeing positive signs in many important areas of the business, in spite of what continues to be a difficult environment for consumers and retailers in general.”

Revamping the bedraggled home department has proven to be a tall order. Ullman admitted that “getting the new home strategy up and running has been ore challenging than originally planned.” He lamented the fact that “the merchandise assortment, shopping environment and price points have nor resonated with customers, and sales trends remain weaker in stores.”

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This rare spat of good news for JCP stitches a shiny seam into an otherwise ashen horizon. Just recently, the company watched  its credit rating humiliatingly downgraded by Fitch Ratings from “B-Minus” to “CCC.”

A spokesman for Fitch said that the downgrade was issued to reflect “higher than expected cash burn in 2013.” Also, they anticipate that JC Penney, despite its recent share  sell-off, will still have to see additional funds next year.

A “CCC” classification, under Fitch’s ratings system, indicates that “default is a real possibility.”

Fitch also said that “the risk for further inventory markdown remains through the holiday season as inventory buys remain aggressive and sales could continue to disappoint.”

According to Fitch, the principal concern is twofold: a much higher than expected cash burn in 2013 and a projected cash shortfall in 2014, pinching JC Penney’s into straitened circumstances. Even with JC Penney adding an additional $3 billion in liquidity this year (and access to $850 million more) it remains a real possibility that the retailer would have to raise even more funds in 2014, especially after what promises to be a punishing holiday shopping season.

As it stands, Fitch forecasts that JC Penney will conclude 2013 with a cash burn of approximately $3 billion, about a billion more than the projections it released in May. JC Penney suffered this year from much weaker than anticipated comp store sales, a listless home department performance, massive markdowns necessary to move piling excess inventory and a significantly contracting gross margin.

As Fitch interprets it, the central problem is not immediate liquidity, since the recent equity offering generated more than $800 million. They also still have the $2.25 billion loan they secured, with the oversight of Goldman Sachs, last May. The more pressing problem is that, sometime during 2014, JC Penney is compelled to borrow even more, likely sinking its stock, frightening already anxious investors and vendors, and leaving itself so over-leveraged it has to sell off physical assets to raise the money it needs to survive.

According to Fitch’s analysis, for JC Penney to continue to fund its annual $400 to $500 million in expenses, plus interest expenses of $360 to $375 million, it must earn at least $750 million before interest, depreciation, taxes and amortization. This means the retailer would have to perform between 14% and 16% above its own projections for 2014, a return to sales between $13.4 billion and $13.6 billion.

Moody’s and S&P, Fitch’s two closest competitors, currently rate JC Penney at Ba1 and BB+ respectively. While the news of Fitch’s downgrade pushed JC Penney’s stock down 3.12%, the bond market seemed unstirred by the news, watching impassively. This is likely because JC Penney’s longer dated bonds continue to perform well, experiencing very little vacillation over the last year, largely trading between 95 cent and 100 cents on the dollar.

Still good news is good news, and JCP will take what it can get. The real test of its comeback resolve will come in the contrails of what is likely to be a disappointing holiday shopping season. Then it will be forced to reassess its fortunes, conceivably make a bid to raise more capital and potentially sell off some physical assets to do it.