J.C. Penney Secures $1.75B Loan [ANALYSIS]

This morning J.C. Penney Company, Inc. (NYSE:JCP) announced that it entered into a commitment letter with lenders to provide the company with a five-year $1.75bn senior secured term loan facility. Proceeds may be used to fund ongoing working capital requirements and other general corporate purposes and to amend, acquire or satisfy and discharge  J.C. Penney Company, Inc. (NYSE:JCP)’s outstanding 7.125% notes due 2023.

While $1.75bn of additional liquidity is certainly a step toward addressing J.C. Penney’s balance sheet issues, analysts at BAML remain concerned about fundamentals as they expect significant margin compression from reintroducing coupons and promotions this quarter, and retain an Underperform rating.

Taking out 2023 notes could enable additional funding J.C. Penney Company, Inc. (NYSE:JCP)’s 7.125% senior notes due 2023 contain a covenant that provides that the company will not issue, assume or guarantee any Senior Funded Indebtedness unless Net Tangible Assets are at least 200% of Senior Funded Indebtedness (simply, Net Tangible Assets/Senior Funded Indebtedness must exceed 2.0x). As of the end of 2012, the company calculated this ratio as 304%.

Based upon the company’s calculation for 2012, BAML’s High Yield debt analyst, Bill Reuter, believes that J.C. Penney Company, Inc. (NYSE:JCP) should continue to be in compliance throughout 2013 absent additional Senior Funded Indebtedness. Reuter thinks that this covenant could be in jeopardy in the event that: (1) asset write-downs would reduce Net Tangible Assets or (2) debt issuance increases Senior Funded Indebtedness. As the 7.125% Senior Notes due 2023 are only $255mn, Reuter believes that J.C. Penney could be able to potentially eliminate the covenant.

Analysts at Credit Suisse note that J.C. Penney Company, Inc. (NYSE:JCP) can now work on truly “fixing” its business from a merchandise and sales promotion perspective. Late May and early June are key months, due to the need to place orders for the important fourth quarter. There are already signs of changes in the promotional strategy with more couponing but with additional restrictions on how they can be used. For example, the company sent out an email to customers on Friday with a 15% off $100 promotion; however, the offer excludes many products such as Mattresses, Kitchen Electrics, Food, Baby Gear, Athletic Shoes, in addition to a multitude of brands including Joe Fresh, Nike, Converse, Vivienne Westwood Watches, among others. This weekend the company ran a one day free shipping event.

This lies in contrast to J.C. Penney Company, Inc. (NYSE:JCP)’s strategy just a few months ago when the company offered a 20% off Friends and Family discount of which Sephora was the only product excluded from the offer. (See Exhibits 1 and 2). Clearly J.C. Penney is now trying to see what promotions will attract customers, in affect experimenting before it commits to a new promotional course.

The addition of approximately $120 million in interest expense is a two edge sword and allows the company to be less focused on liquidity in the near-term but at the expense of profitability. Even with a 5% positive revenue assumption for next year CS thinks that profitability is uncertain. CS admires the decisive step that management has taken to ensure liquidity, but  continue to be cautious as to the ultimate earnings power the entity can enjoy.

However, analysts at Gilford note that for the last few months, Penney relied on coupons to revive consumers’ interest. Coupons brought in traffic but apparently not as much sales as they had judged. In late April, promotional  events resumed. Sales have apparently increased. They anticipate increases for Mother’s Day and other upcoming key shopping dates.