NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a 'BB-/RR1' rating to J.C. Penney's new five-year $1.75 billion senior secured term loan facility. The closing of the new facility is contingent upon the successful tendering or defeasance (of at least two-thirds of the amount outstanding) of the $225 million in debentures due 2023. In addition, Fitch has affirmed its Issuer Default Ratings (IDRs) on J.C. Penney Co., Inc. and J.C. Penney Corporation, Inc. at 'B-'. The Rating Outlook is Negative. A full list of rating actions follows at the end of this press release.
KEY RATING DRIVERS
The new $1.75 billion term loan facility will be secured by (a) first lien mortgages on owned and ground-leased stores (subject to certain restrictions primarily related to Principal Property owned by J.C. Penney Corporation, Inc.) with an aggregate value of not less than $400 million, the company's headquarters and related land, and nine owned distribution centers; (b) a first lien on intellectual property, machinery, and equipment; (c) a stock pledge of J.C. Penney Corporation and all of its material subsidiaries and all intercompany debt, and (d) second lien on inventory and accounts receivable that back the $1.85 billion asset-backed (ABL) facility.
The proceeds of the term loan will be used to fund operations, working capital, and capital expenditures and to amend, acquire or satisfy and discharge the company's $255 million outstanding 7 1/8% debentures due 2023 to get rid of all restrictive covenants. The terms of these debentures required the company to maintain a ratio of net tangible assets to senior funded indebtedness of 2.0x and above (under which it could have only incurred $1.4 billion in debt at the end of 2012), which would have proven to be too restrictive. Defeasance or tendering of the debentures also removes any restrictions on its ability to draw on its $1.85 billion credit facility as a long-term debt source.
The financing maxes out the incremental amount of first- and second-lien debt JCP can incur, although it could issue unsecured, subordinated debt, convertible notes or preferred equity.
Fitch views the injection of additional capital as a positive to fund operations in 2013 given a projected cash burn of $1.7 billion-$1.9 billion. Fitch currently assumes EBITDA of negative $500 million on top-line contraction in the high single digits, $800 million in capital expenditures (substantially similar to 2012 levels) and potential working capital use of $200 million to $300 million. In addition, the company has to fund the defeasance or tendering of the 2023 debentures.
Beyond 2013, Fitch estimates that the company will have to generate a minimum of $750 million to $900 million in EBITDA to fund ongoing capital expenditures in the $400 million-$500 million range and cash interest expense of $360 million-$375 million. This would require the company to return sales to about $14 billion, or 8% above 2012 levels, and realize gross margins in the 39%-40% range given the current cost structure, and some expected incremental investments in areas such as advertising and marketing to prop up sales via a return to a high-low pricing strategy.
This appears to be an ambitious level and therefore, free cash flow is still expected to be materially negative in 2014. However, the reintroduction of coupons which is underway, the imminent completion of the very extensive and disruptive home furnishings makeover, the return of critical brands such as St. John's Bay (which Fitch estimates used to generate in excess of $1 billion of sales but was eliminated in major categories), and the addition of new brands should stem the pace of decline in the business as incurred in 2012 and expected in first quarter 2013. The speed and ability of the company to stabilize sales and return to positive comparable store sales growth will determine additional funding requirements in 2014 and beyond. As of now, Fitch expects liquidity, between the new term loan and the $1.85 billion credit facility, to be adequate through 2014.
Issue Ratings Based on Recovery Analysis
For issuers with IDRs at 'B+' and below, Fitch performs a recovery analysis for each class of obligations of the issuer. The issue ratings are derived from the IDR and the relevant Recovery Rating and notching, based on Fitch's recovery analysis, that places a liquidation value under a distressed scenario of over $5 billion as of Feb. 2, 2013 for J.C. Penney.
J.C. Penney's $1.85 billion senior secured credit facility that matures in April 2016 is rated 'BB-/RR1', indicating outstanding recovery prospects (91% - 100%) in a distressed scenario. The facility is secured by inventory and receivables with borrowings subject to a borrowing base. The company is subject to a springing covenant of maintaining fixed-charge coverage of 1.0x if the availability falls below the greater of (i) 10% of line cap (the lesser of total commitment or borrowing base) and (ii) $125 million.
The $1.75 billion new term loan expected to mature in May 2018, which will be backed by the collateral as discussed above, is also expected to have outstanding recovery prospects of 91% - 100%, leading to a 'BB-/RR1' rating.
The $2.9 billion of senior unsecured notes are rated 'B-/RR4', indicating average recovery prospects (31% - 50%). The ratings had already reflected Fitch's expectation that the company would need to incur additional secured debt in 2013 to fund operations. Fitch expects to withdraw its rating on the 2023 debentures when it has been successfully defeased or tendered.
Fitch has taken the following rating actions:
J.C. Penney Co., Inc.
--IDR affirmed at 'B-'.
J.C. Penney Corporation, Inc.
--IDR affirmed at 'B-';
--$1.85 billion senior secured bank credit facility affirmed at 'BB-/RR1';
--$1.75 billion senior secured term loan assigned 'BB-/RR1';
--Senior unsecured notes and debentures affirmed at 'B-/RR4'.
The Rating Outlook is Negative.
RATING SENSITIVITIES
A negative rating action could occur on worse-than-expected deterioration in EBITDA that further constrains cash flow and liquidity, and impedes the company's day-to-day operations.
A positive rating action could occur if the top-line starts to stabilize, the company realizes more normalized gross margin levels, and does not need additional financing to fund operations.
Additional information is available at 'www.fitchratings.com'
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Evaluating Corporate Governance' (Dec. 12, 2012);
--'Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers' (Nov. 13, 2012).
Applicable Criteria and Related Research
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=693773
Evaluating Corporate Governance
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=694649
Corporate Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=684460
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=790042
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