APRIL 2020 JCPENNEY BONDS RECOMMENDATION
In our highest-risk corporate bond recommendation to date, BondSavvy recommended subscribers buy JCPenney bonds 5.65% 6/1/20 on April 4, 2020 at a price of 54.67. The bonds initially spiked to the mid-70s but then plummeted after JCP announced April 15 that it was skipping an interest payment on JCP bonds maturing in 2036, entering a 30-day grace period to make payment before the non-payment would be an event of default under the JCPenney bond indenture. On May 7, JCP issued an 8-K saying that it skipped a $17 million JCPenney debt payment on its term loans and entered into a five-business-day grace period to make the debt payment.
JCPenney Chapter 11 filing
Things then got even more interesting when JCP filed another 8-K at 10:08am on May 15, 2020 saying that it paid the $17 million term loan interest payment. This caused JCP stock to surge 21% during the day in the hopes that a JCP Chapter 11 filing was not imminent. When we saw this announcement, however, it did not say that JCP also had made the payment on the JCPenney bonds due in 2036. This told us that something was afoot, which was confirmed with the JCPenney Chapter 11 filing later that day.
In its announcement, the company said JCPenney debt will be reduced by 'several billion dollars' and that 70% of its first-lien lenders have signed on to a 'restructuring support agreement,' which provides additional financing to help JCP operate during Chapter 11. On the positive side, the JCPenney Chapter 11 filing will enable the company to reduce its store footprint and debt and give the company a fighting chance to survive. JCP locked up its management team with bonuses that have to be repaid by the executives should they not stay with the company for the next two years.
What this means for the '20 and '36 bondholders
We estimate JCP had approximately $4-$4.25 billion in debt when it filed for bankruptcy. Since the company said it will eliminate 'several billion dollars of debt,' the '20 and '36 bonds will, no doubt, be part of the debt that gets eliminated and, hopefully, exchanged for some equity and perhaps a small amount of cash.
Based on JCP's press release, it's likely the company emerges from bankruptcy with $1.25-$1.5 billion of total debt. Our potential recovery depends on the valuation of the business and the terms approved by the US Bankruptcy Court for the Southern District of Texas, in Corpus Christi. The company indicated that it 'will explore additional opportunities to maximize value, including a third-party sale process.' Needless to say, there will be a lot of moving parts.
Since JCP has not disclosed the restructuring plan to the public, we do not have further detail on potential recoveries. This process will play out over the next several months, and we will provide updates to subscribers as they come.
Our other corporate bond recommendations
Our corporate bond recommendations are generally for bond issuers with much stronger financials than JCPenney. We identify bonds that trade at compelling values relative to the issuing company's financials and offer strong total return opportunities. Please click here to see the returns generated from prior corporate bond recommendations, which include both investment-grade and high-yield corporate bonds. Click here to view a sample edition of The Bondcast where we presented four new corporate bond recommendations.
Agenda for this blog post
This blog posts covers two sets of recommendations of JCP bonds: First, our recent JCPenney bonds recommendation on April 4, 2020 and then recommendations we made for JCPenney bonds in late 2018, which we sold May 28, 2019 due to eroding JCPenney financials. We have made the JCPenney bonds recommendation publicly available so prospective subscribers can see the level of financial analysis and business analysis BondSavvy conducts when making investment recommendations. Please note that this is only a preview of our recommendation for JCPenney bonds. Our presentation on April 4, 2020 was an hour-long webcast complete with subscriber Q&A, and we have made this available to the public below.
April 4, 2020 Presentation to BondSavvy Subscribers Recommending JCPenney Bonds
© 2020 BondSavvy
TABLE OF CONTENTS
Summary of Our April 4, 2020 JCPenney Bonds Recommendation
The above video on JCPenney debt provides the full analysis we presented to BondSavvy subscribers April 4, 2020. Following is an overview of parts of our recommendation and analysis of JCPenney debt.
While we previously recommended selling JCPenney bonds in 2019, as JCPenney bond prices fell in the wake of the COVID-19 pandemic, we recommended subscribers purchase JCPenney bonds due 6/1/20 at a price of 54.67 on April 4, 2020. During a subscriber webinar, we discussed the following:
1) COVID-19 impact on JCPenney bonds and business
2) What action JCPenney had taken to increase liquidity and reduce expense
3) BondSavvy's monthly projections for JCPenney's financials, showing how much cash JCP will burn and how it can address 2020 JCPenney bond maturities
4) JCPenney's capital structure and where the recommended JCPenney bonds rank in terms of seniority to the other JCPenney debt
5) Recent trading activity of JCPenney bonds, including the JCP '20 bond (CUSIP 708130AD1)
6) The potential value of JCP's real estate portfolio
Before we get into projecting JCPenney financials for 2020, it's important for bond investors to know how JCPenney had been performing up to when COVID-19 took hold. As shown below, 2018 was a rough year for JCPenney, as EBITDA declined 33% due, in part, to the company needing to clear significant inventory at bargain basement prices. In May 2018, JCPenney CEO Marvin Ellison quit to become CEO of Lowe's Corp., and JCPenney was without a CEO until it hired Jill Soltau in October 2018. Soltau then filled out the JCP executive management team during 2019.
The results, just over a year into Soltau's tenure, had been encouraging. In 2019, JCPenney exited the major appliances and in-store furniture segments. While this contributed to 2019 revenues falling 7%, JCPenney gross margins increased 2.7 percentage points due to higher selling margins and lower shrinkage. EBITDA increased slightly and, in JCPenney's February 27, 2020 earnings call, JCPenney projected 5-10% EBITDA growth for 2020.
JCPenney Financials - 2017 to 2019
$ in millions
Then, unfortunately, COVID-19 took hold, and JCP closed all of its stores on March 18, 2020. On March 31, it announced the company would furlough the majority of store hourly associates effective April 2 and, beginning April 5, it would furlough a significant portion of corporate employees and store salaried employees. With JCP pulling its 2020 financial guidance in March, we are left to project JCPenney financials for 2020 to determine if it has the financial wherewithal to make it through 2020.
In mid-March 2020, JCPenney drew down on its $1.25 billion credit line, which increased JCPenney's cash balance to approximately $1.6 billion. Below we preview our projected 2020 JCPenney financials to estimate the level of JCPenney cash burn for 2020 and the company's likelihood of it paying the $105 million in JCPenney bonds that are due June 1, 2020.
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JCPenney 2020 Revenue Assumptions
We begin our model with JCPenney revenue assumptions. For this, we have quarterly revenue from 2019 JCPenney financials, and we have assumed each month's revenue within a quarter is equal to that quarter's revenue divided by three. JCPenney's fiscal year ends on the Saturday closest to January 31, which, this year, ended February 1, 2020.
We then assumed JCPenney will retain a percentage of 2019 revenue based on our monthly assumptions on the impact of COVID-19 on JCPenney's stores. JCPenney closed its stores March 18, so it did have fairly normal revenue for at least part of Q1 2020. We expect virtually no sales in company stores during April and May 2020, with stores partially opening in June and more in subsequent months as conditions hopefully improve.
JCPenney 2020 Gross Profit Assumptions
We have assumed JCPenney's gross margins will dip below 2019 levels for a good chunk of fiscal 2020, as a greater portion of customer purchases will have e-fulfillment and the related shipping costs, and JCPenney will likely need to clear out unsold inventory. JCPenney had increased gross margins from 34.5% in 2018 to 37.2% in 2019 due to higher selling margins and a decrease in shrinkage. It had been on the right path, but COVID-19 will set JCP back, unfortunately.
JCPenney 2020 Expense and Cash Flow Assumptions
Certain assumptions for JCPenney financials are straightforward, including lease expense, repayments under its term loan, and interest expense on all JCPenney debt. We have also assumed that advertising expense remains similar to the 5.6% of revenue it was for 2019. The art of projecting expenses for JCPenney's financials lies in our employee compensation assumptions. Per the JCPenney 10-K, we know JCP had 90,000 employees as of February 1, 2020. JCPenney does not indicate what portion of its workforce is part time; however, based on our review of other retailer financials, we have assumed that two-thirds of JCPenney's employees are part time.
As shown below, we have split JCPenney's employees into full- and part-time employees and then made assumptions regarding how long the recently announced JCP furloughs would stay in place. We have also made compensation assumptions for each type of employee. Subscribe to see our complete projections for JCPenney's financials and all of our previous corporate bond recommendations, including the eight we presented between March 26, 2020 and April 4, 2020.
How We Projected JCPenney's Financials - February to December 2020
$ in millions
This financial analysis was a major part
of the April 4, 2020 webinar we presented to BondSavvy subscribers to discuss our analysis of the JCPenney
bonds. BondSavvy's subscribers are primarily self-directed individual investors and financial advisors
managing money on behalf of individual investors. With each investment presentation, our goal is to
empower subscribers to get their arms around the business of the issuing company and to fully understand the
risk-return opportunity. It is then the subscriber's ultimate decision as to which BondSavvy
recommendations he or she invests.
Following is our original post from 2018 on a previous JCPenney bond recommendation we made public subsequent to providing the recommendation exclusively to BondSavvy subscribers.
The following post is a recommendation for JCPenney bonds
BondSavvy made to subscribers September 10, 2018 at an offer price of 92.65 for the JCPenney 5.65% 6/1/20 bonds
("JCP '20 bonds"). We then recommended subscribers purchase additional amounts of the JCPenney bonds on November
19, 2018 at a price of 82.04. On May 28, 2019, given the continued worsening of JCPenney's credit profile, we
recommended subscribers sell the JCPenney bonds, which were quoted that day at a price of 85.15 / 86.96.
ORIGINAL BLOG POST FROM NOVEMBER 2018
BondSavvy investment recommendations do not take into account an investor's specific financial situation and do not represent personalized bond investment advice. Please read our full disclaimer prior to reading this high yield bond investment analysis.
JCPenney's (NYSE: JCP) first- and second-quarter 2018 struggles have created an investment opportunity in its 5.65% 6/1/20 bonds (CUSIP 708130AD1, "JCP '20" bonds), which we recommended that BondSavvy subscribers buy September 10, 2018. While we - and everyone else - are disappointed with JCPenney's financials, we believe the company has time to engineer a turnaround since it has limited near-term bond maturities.
Prior to 2018, J.C. Penney had been staging a turnaround from the dark days of 2012-13. You'll see that EBITDA had grown to approximately $1 billion in both 2016 and 2017 and comparable-store sales had stabilized:
Figure 1: J.C. Penney EBITDA and Same-Store Sales Growth
| *EBITDA represents management's 2018 projection per
its Q2
2018 earnings call. Same-store sales growth is for Q2 2018.
|
The pricing of the JCPenney bonds has largely followed the performance of the business, declining over 30% from 2011 to 2013 and then climbing back to par as EBITDA grew to $1 billion in 2016 and 2017. That said, the price of the JCPenney bonds is now in the low 90s following the company's struggles during the first half of 2018 as shown in Figure 2:
Figure 2: Price Performance of J.C. Penney 5.65% 6/1/20 Bond
We show later the dollar amount and timing of maturities for all JCPenney bonds. Given JCPenney's financials and the limited near-term maturities, we believe the JCPenney bonds offer a compelling 10.91% yield to maturity and are money good based on current financials.
Today vs. Late 2017
When we analyzed JCPenney bonds in December 2017, we saw a company that was turning the corner and with certain of its bonds trading at all-time lows. We believed this created a compelling risk-return opportunity at the time. Over the last several quarters, the company has paid down debt and extended certain bond maturities; however, JCPenney financials worsened for the six months ending Aug. 4, 2018, as shown in the below table:
Figure 3: Financial Comparison - October 2017 Vs. August 2018
| $ in millions
|
October
2017(1)
|
August
2018(2)
|
| Trailing 12 Months EBITDA
|
$1,008
|
$789
|
| Leverage Ratio (3)
|
4.3x
|
5.1x
|
| Interest Coverage Ratio (4)
|
3.2x
|
2.5x
|
| Last Quarter's Comp.-Sales Growth
|
+1.7%
|
+0.3%
|
| Fiscal YTD EBITDA Growth
|
-0.2%
|
-42%
|
| Total JCPenney Debt
|
$4,324
|
$4,054
|
| Debt Maturities Through June 1, 2020(5)
|
$880.6
|
$233
|
(1)Financial data as of, or for the period ending, Oct. 28, 2017.
(2)Financial data as of, or for the period ending, Aug. 4, 2018.
(3)Total debt divided by trailing 12 months EBITDA.
(4)Trailing 12 months EBITDA divided by most recent quarter's annualized interest expense.
(5)In addition to bond maturities, includes $42 million each year that J.C. Penney is required to pay down on its $1.6 billion Term Loan Credit Facility.
The most important thing JCPenney did was pay down and refinance some JCPenney bonds. As shown in the above table, through June 1, 2020, JCPenney now has to pay back $233 million of debt, a $648 million reduction since Q3 2017. On its Q2 2018 earnings call, the company projected $700 million of fiscal year 2018 EBITDA, a drop of 30% from fiscal 2017. If this number holds, it would raise JCP's Leverage Ratio to 5.8x.
The key question is how quickly JCPenney's financials can turn around. As shown above, EBITDA for the first six months of fiscal 2018 fell 42%. The big driver of this was a reduction in gross margin driven by significant discounting to clear excess inventory. Management explained that, following strong performance in fiscal 2017, the company stocked its stores too aggressively leaving them with too much inventory. While certain parts of JCPenney's business have shown strength, such as children's, jewelry, salons, and Sephora stores within a store, the incoming CEO - whenever he or she is hired to replace Marvin Ellison, who left in May to become CEO of Lowe's Corp. (NYSE: LOW) - will need to ensure inventory mismanagement goes away.
Detailed Look at Upcoming Maturities
As shown in Figure 4, there are limited JCPenney debt maturities through 2022: $160 million in bonds, $177 million outstanding on its 2017 Credit Facility, and $42 million per annum for its $1.6 billion Term Loan Credit Facility, which comes fully due June 23, 2023. We therefore believe JCP has limited near-term bankruptcy risk and enough time to foster a turnaround.
Figure 4: JCPenney Debt Maturities ($ in Millions)
| Maturity Date
|
Amount Due
|
Security
|
Yield to Maturity(1)
|
| Oct. 1, 2019
|
$50
|
8.125% Senior Notes '19
|
8.12% @ par
|
| June 1, 2020
|
$110
|
5.65% Senior Notes '20
|
10.91% @ 92.00
|
| June 20, 2022
|
$177
|
2017 Credit Facility
|
N/A
|
| June 23, 2023(2)
|
$1,604
|
Term Loan Credit Facility
|
N/A
|
| Nov. 15, 2023
|
$500
|
8.875% Sr Secured Notes '23
|
144A offering(3)
|
| 2025
|
$400
|
8.625% Sr. Secured Second Priority Notes '25
|
144A offering(4)
|
| 2036-37
|
$701
|
6.375 '36, 7.4% '37
|
15-16%
|
| 2097 | $500 | 7.625% '2097 | 16.5% |
| Other
|
$12
|
||
| JCPenney Debt | $4,054 |
(1)Yields to maturity based on pricing of recent trades during September 5-September 7, 2018. JCP '20 bonds based on Fidelity.com offer price at 2:00pm ET on Sept. 10, 2018.
(2)We show the Term Loan Credit Facility as one maturity in 2023; however, J.C. Penney is required to pay down $42 million each year between now and the maturity date.
(3)Not available to individual investors.
(4) Not available to individual investors.
JCPenney showed that it has access to the capital markets when it issued the 8.625% '25 notes in March 2018. The issuance was upsized from $350 million to $400 million. We like the 5.65% '20 bonds since there is only $50 million in JCPenney debt maturities before them, and we believe J.C. Penney will be able to pay off the '20 bonds with cash flow from operations.
CEO Search and Conclusion
With former CEO Marvin Ellison leaving in May, JCPenney has been searching for a new leader. On the company's Q2 earnings call, it mentioned that it was interviewing a number of highly interested candidates but did not provide a timetable for the hiring. Given the recent fall in JCPenney stock, we believe this could be a compelling opportunity for someone to come in and right the ship (hopefully making a lot of money for him/herself and shareholders in the process). While Ellison did a nice job helping bring JCPenney back from the brink, the company had a big slip up in the first half of 2018, especially as other retailers such as Nordstrom (NYSE: JWN), Kohl's (NYSE: KSS) and Macy's (NYSE: M) have shown strong performance.
We expect Q3 to be bumpy for JCPenney; however, assuming a new CEO is brought on shortly, we hope to see some positive momentum in JCPenney's financials soon. This will help us decide how much longer we want to own the JCPenney bonds.