Imperial Capital analysts have maintained their Underperform rating on J.C. Penney Company, Inc. (NYSE:JCP) and lowered their price target to $2.50 from $5.00.

J.C. Penney JCP

Analysts Mary Ross-Gilbert and Seweryn Sztalkoper of Imperial Capital, however, maintained their Buy rating on the longer-dated senior notes of JCP.

Substantial debt burden

The Imperial Capital analysts anticipate JCP’s financial results to improve significantly over the next couple of years. However, the analysts believe J.C. Penney Company, Inc. (NYSE:JCP)’s increased debt levels associated with cash burn and the anticipated improvement in EBITDA doesn’t sufficiently justify JCP’s current price.

The analysts halved J.C. Penney Company, Inc. (NYSE:JCP)’s price target to $2.50 reflecting the optionality of the shares and their valuation is based on their lower 2015 EBITDA estimates of $508 million and a midrange valuation multiple of 6x. This is in consonance with the multiple commanded for Macy’s based on the consensus EBITDA estimate for FY 15.

However, the Imperial Capital analysts point out that Macy’s has an EBITDA margin of over 15% and is solidly executing and delivering a strong performance, despite facing consumer headwinds and intensified promotional activity.

Longer-dated senior notes get BUY rating

The Imperial Capital analysts believe J.C. Penney Company, Inc. (NYSE:JCP)’s longer-dated senior notes maturing in 2020-2097 will trade-up by over 10 points for potential returns of about 30%, aided by anticipated favorable operating momentum in F1Q14 and F2Q14, benefiting from the restoration of assortments in the ‘home’ department, which was closed for the better part of 2013, reduced excess clearance activity and continuing improvements to merchandise categories throughout the store. The Imperial Capital analysts maintain their Buy rating on JCP’s longer-dated senior notes maturing in 2020-2097.

The analysts however maintain their Hold ratings on JCP’s shorter-dated senior notes maturing 2015-2018. The analysts believe the bonds may also trade-up on anticipated favorable operating momentum but to a lesser degree than the longer-dated bonds. However, the analysts believe if J.C. Penney Company, Inc. (NYSE:JCP) is forced to restructure ‘down the road’, prices on the shorter-dated bonds will likely compress to match prices on the longer dated bonds.

The following table captures J.C. Penney Company, Inc. (NYSE:JCP)’s proforma select loans and securities covering both longer-dated and shorter-dated senior notes:

JCP's Loans and securities

The analysts point out that their valuation of J.C. Penney Company, Inc. (NYSE:JCP) highlights the limited recoveries to the unsecured debt, which explains the analysts’ recommendation to hedge a long position in the longer-dated notes by shorting the shares and/or the shorter-dated notes.

Liquidity analysis

Turning their focus to J.C. Penney Company, Inc. (NYSE:JCP)’s liquidity estimates, the analysts anticipate JCP could end FY 14 with $1.43 billion in cash for total liquidity of $2.8 billion. The analysts point out that following their lower earnings and commensurate higher cash burn estimates of $564 million, $185 million, $431 million in F1Q14 to F3Q14 respectively, they anticipate the low point in JCP’s total cash position of $507 million on 11/1/14 for total liquidity of $1.357 billion. The following table highlights JCP’s 2014 quarterly liquidity analysis outlook:

JCP's liquidity analysis outlook