Best Bond To Buy Now: JCPenney 5.65% '20

Best Bond To Buy Now: JCPenney 5.65% '20

This fixed income investment blog post contains a high-yield corporate bond investment recommendation BondSavvy provided to its subscribers on September 10, 2018.  Our founder Steve Shaw later posted the pick on Seeking Alpha, which you can view here.  We are making this investment recommendation publicly available so prospective subscribers can see the level of financial analysis and business analysis BondSavvy conducts when making investment recommendations. 

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.


J.C. Penney'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 clients buy on Sept. 10. While we - and everyone else - are disappointed with JCP's recent performance, 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 JCP '20 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 JCP '20 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 debt maturities for J.C. Penney. Given JCP's cash flow and the limited near-term maturities, we believe the '20 bonds offer a compelling 10.91% yield to maturity and are money good.


Today vs. Late 2017

When we analyzed J.C. Penney's 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, performance has waned 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 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 J.C. Penney did was pay down and refinance some of its near-term debt. As shown in the above table, through June 1, 2020, J.C. Penney 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 the company's poor year-to-date performance 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 J.C. Penney'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, J.C. Penney has limited 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: J.C. Penney Upcoming 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
  $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.

J.C. Penney 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 bond 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, J.C. Penney 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 J.C. Penney's 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 J.C. Penney 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 J.C. Penney; however, assuming a new CEO is brought on shortly, we hope to see some positive momentum in Q4. This will help us decide how much longer we want to own the J.C. Penney bonds.

Disclosure
BondSavvy founder Steve Shaw owns the JCP '20 bonds, as well as every individual corporate bond recommended by BondSavvy.  He does not own JCP stock.

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