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JCP’s Credit Crunch: Signs of Hope?

After JC Penney (JCP) reported a monumental $586 million loss for the second quarter ending August 3rd, widespread attention has turned to the company’s overall financial profile. Fears about the company’s creditworthiness already swirled about the industry last July when factoring firm CIT placed a considerable basket of orders on hold, ostensibly worried about its cash flow.

However, despite the retailer’s generally straitened circumstances, and the recent reported losses, many analysts are now feeling reassured about JCP’s short term fiscal health, especially since it maintains its year-end liquidity estimate of $1.5 billion. Bob Carbonell, executive vice president and chief credit officer for Bernard Sands, said, “I think it’s the first time the company hit a liquidity number in years. Three months ago, the retailer said it would hit $1.5 billion in liquidity at the end of the year, and that’s what they did in their earnings report. I believe there is enough liquidity for the rest of the year.”

At least for now, Carbonell continued, JCP remains on solid footing with its creditors. “We are telling clients to deal with Penney’s on an order-by-order basis. It now remains to be seen how they do for the rest of the back-to-school selling season.”

Other analysts have largely seconded Carbonell’s cautious optimism. Speaking off the record, one credit analyst offered, “There was no major red flag to chase people away. It was bad, but it could have been worse. While there was no major reason for optimism, there is some light at the end of the tunnel.”

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Another industry insider, also speaking anonymously, also expressed a glimmer of hope about JCP’s future prospects. “There was a lot of concern about whether they have enough cash in place. That is what people are responding to. With a plan in place, things are starting to look better. What they’re saying is they’re going back to their roots. I like it,” he said.

But not everyone is prepared to celebrate just yet. William Susman, founder of the research firm Threadstone partners, gave a more wary appraisal. “JCP is a capital-intensive turnaround with limited current liquidity. The vendor base has no choice but to sell them. However, they are out of the mall and in neverland if they believe they will make their margins,” he said.

And the question of gross margins have surfaced as a major point of concern. Over the second quarter, JCP’s gross margin nose-dived to 29.6% from 33.2%. One credit analyst surmised that JCP could likely improve its standing by as much as 100 basis points over the next quarter given the proper strategy.

“Penney’s can do that by loading up the inventory to drive sales. I feel pretty comfortable about the direction they’re heading in,” he said.

JCP CEO Mike Ullman is aware of the mounting disquiet regarding the issue and specifically addressed it on a conference call with analysts recently: “Our private-brand penetration is central to restoring ourselves to historical gross margins and we believe this can be done during our turnaround.”

Kenneth H. Hannah explained that the margin rates were caused by “unusually high markdowns and clearance merchandise sales, lower-than-expected sales in general and a return to promotional activities, including coupons and sales events as we return to a more competitive promotional pricing model.”

Also, JCP’s gross margin dip seems to be a function of their inability to drive consumer traffic and convert the traffic they do enjoy. Paul Lejuez, a credit analyst at Well Fargo, observed that JCP was “burned by the effect by the effect of a failed turnaround strategy, which created a hole which is just too deep.”

JCP’s second quarter losses brings its total reported losses to $934 million, a considerable leap from the tally at this point last year of $310 million. Sales have plunged in the second quarter 11.9% and 14.2% for the year in total so far.

CEO Mike Ullman, lately embroiled in controversy as hedge-fund manager William Ackman publicly demanded his ouster, remains intransigently optimistic. “Over the last four months or so since I returned to the company, we’ve been focused on moving as quickly as possible to stabilize the business, not just financially, which we’ve made a meaningful progress on, but also operationally including merchandising, marketing, store experience, as well as the leadership team,” he said.

Still, Ullman tempered his enthusiasm with a pragmatic concession that there are “no quick fixes to crack the errors of the past.” Part of the problem has been JCP’s consistent challenges with inventory. He said, “As I told you in May, coming into the second quarter, we’re going to be out of stock in key basic items for our customers which they trusted us to have when they came to jcpenney. We spent the last three months getting back in-stock and what the customers need and we fully expect to be in great shape by the fourth quarter.”