Imperial Capital analyst Mary Ross Gilbert issued new ratings for retailer J.C. Penney Company, Inc. (NYSE:JCP) in her Capital Structure Focus of October 21, 2013.

J.C. Penney JCP

Much of her analysis takes into account a likely bankruptcy restructuring by J.C. Penney Company, Inc. (NYSE:JCP) in 2014 and its effect on the beleaguered retailer’s outstanding debt and listed shares.

Why is JCP’s bankruptcy likely?

Ross Gilbert says recurrent negative publicity speculating on JCP’s bankruptcy “appears to be wearing down vendors and management…and as a result, the Board may find that it ultimately has no choice but to seek bankruptcy court protection via a voluntary filing in 2014, if vendors tighten trade credit terms and investors prove to be unwilling to support…”

She also points out that rumors flew about a reported freeze on credit to J.C. Penney Company, Inc. (NYSE:JCP) by Export Canada.

Indeed, Goldman Sachs Group Inc (NYSE:GS) raised the red flag on Chapter 11 at JCP on September 25 when its fixed-income research issued a report downgrading JCP debt, and warning investors that the company could be headed for bankruptcy.

On October 15 the shares of J.C. Penney Company, Inc. (NYSE:JCP) fell 9% on rumors that the company had appointed bankruptcy counsel. The company vehemently denied this.

Ross Gilbert’s own view is that JCP faces increased risk of a financial restructuring in the absence of a white knight investor with deep pockets who could provide both financial and “halo” support to the struggling retailer.

J.C. Penney’s equity shares

Ross Gilbert reaffirms the Underperform rating on J.C. Penney Company, Inc. (NYSE:JCP) shares but takes the axe to their 12-month price target – reducing it from $5 to $1. “Our new $1 price target is based on the notional ‘option’ value of the shares, given our increasing concerns the company may engage in a financial restructuring in 2014,” she says.

Shorter-maturity bonds (2015-2018)

Ratings are cut from Hold/Buy to Sell for restructuring risk as explained above and also because the risk profile is compressing prices of shorter-dated bonds compared to the longer maturity bonds.

Longer-dated bonds (2020-2097)

Ross Gilbert advises investors to hedge by shorting the equity shares or the shorter-term bonds. She says in the event JCP turns out to be viable these bonds could deliver “equity type returns” provided the downside is hedged as suggested.