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JCP October Sales Surge; Serious Troubles Remain

Ailing retailer JC Penney (JCP) is finally showing some signs of measurable improvement, providing a much needed reprieve from an otherwise endless train of bad news. The company enjoyed a significant increase in same-store sales for the month of October, a promising indication that progress is being made.

Sales jumped 0.9% for October, a substantial improvement in light of the fact that September suffered a 4% decline. A company spokesperson said that the stronger performance was largely attributable to improved inventory in central private brands as well as an overhaul of the home goods department.

CEO Myron Ullman said, “JC Penney has made significant progress in addressing the challenges it faces, and we believe the company is on the right track to return to long-term profitable growth.”

Much of Ullman’s turnaround strategy for JCP amounts to a grand undoing of the damage wrought by former CEO Ron Johnson’s disastrous tenure. Johnson deemphasized promotional discounts, reinvented the home department to focus on more expensive designers and brands and reorganized stores so products were grouped by brand rather than category. JCP is also winding down its controversial deal with Martha Stewart, which Macy’s alleged was an infringement on a preexisting arrangement it had with her company, promising exclusivity.

Still, considerable anxieties remain regarding the snail’s pace of JCP’s rebound back into profitability. Many industry analysts acknowledge that the increased sales are a good sign, but that other metrics are actually more significant portents of JCP’s future viability as a retailer.

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Speaking to the Wall Street Journal, David Tawil, portfolio manager of Maglan Capital, said, “The important metrics will be gross margin and cash burn, not comp store sales.”

Kristen McDuffy, a credit analyst at Goldman Sachs, concurred: “We expect results to be weak, as improving comps are offset by poor gross margins.”

The prospect of a future liquidity crisis looms large for many.  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.”

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.

But others still feel reassured by the news of October’s sales, especially suppliers addled with concerns that JCP’s increased sales come at the expense of gross margins, which have been hurt by an overhang of inventory from the first two quarters of the fiscal year and steep promotional discounts. Some suppliers who use third-party financing to pay for their deliveries have been confronted by tighter credit, hit by increased surcharges from some factoring companies that do business with JCP. These suppliers have continued to ship to JCP despite the additional costs and increased financial exposure partly because of the expectation that JCP’s sales are in the ascendent.

JCP’s stocks remain low even falling this last Tuesday to $8.31. For the year overall, share prices are down 58 percent. However, the retailers bonds have held strong; a bond that comes to maturity in October 2036 gained 11 percent in the last week to 71.8 cents, now yielding 9.4%.