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Fitch Ratings Questions J.C. Penney’s ‘Untenable’ Capital Structure

Fitch Ratings on Wednesday downgraded J.C. Penney Co. Inc.’s issuer default rating to “CCC+” from “B-,” putting the retailer’s loan debt in junk territory.

The credit ratings agency said the downgrade reflected continued market share losses and declining EBITDA (earnings before interest, taxes, depreciation and amortization), with “lack of visibility for a material turnaround” although there are no near-term liquidity concerns.

Fitch also called the company’s long-term direction and strategy “somewhat uncertain given recent senior management changes [as] its near-term focus has been on adding key positions to its management team, exiting out of low gross margin businesses, such as appliances and in-store furniture, and cutting back significantly on inventory to improve gross margins.”

What’s more, the ratings agency is concerned that Penney’s hasn’t shared its long-term strategic plans or outlined any steps to address its capital structure.

Annual EBITDA is expected to be under $500 million over the next 12 months to 36 months, with low-to-mid $400 million projected in 2019 and 2020. That’s a decline from EBITDA of $563 million in 2018. Putting the declines in perspective over the last two years, EBITDA—a metric used to measure a company’s operating performance—was $886 million in 2017.

Penney’s capital structure, according to Fitch, is “untenable” at the current EBITDA run rate, even though near-term liquidity remains adequate to fund seasonal working capital and pay down moderate near-term debt maturities. The company has a $40 million annual term loan amortization, notes of $50 million due in 2019 and $105 million due in 2020. Fitch estimated annual free cash flow to be “negative $100  million to $200 million in 2019 and 2020.”

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Over the summer, J.C. Penney reportedly hired advisors to review debt restructuring obligations. It has about $4 billion in total debt due over the next few years. And while no one is expecting the retailer to go bankrupt anytime soon–it still has about $1.5 billion available under a $2.35 billion revolving credit line–the retailer does need to figure out how to curtail ongoing losses, as well as buy more time to effect its turnaround plans.

Fitch estimated that based on current trends, liquidity could decline from over $1.5 billion at the end of 2019 to the $1.2 billion range at the end of 2020.

Penney’s 2019 comps are pegged to be down close to 8 percent, and in the negative low-single-digit range in 2020 due to continued weakness in key categories and ongoing traffic challenges at mid-tier mall-based apparel retailers, Fitch said.

As for apparel sales, Fitch noted that women’s apparel represented $2.6 billion, or 22 percent of revenue, in 2018. The business has been declining by 6 percent to 7 percent annually since 2016. For the same period, men’s apparel and accessories represented 21 percent of revenue and children’s clothing was 9 percent in 2018, but the two categories have also declined in the 3 percent to 6 percent range since 2016.

While CEO Jill Soltau plans to expand in softlines, Fitch viewed the turnaround in apparel as “challenging,” noting that the retailer will be playing “catch-up to both existing and new entrants in a crowded space.”