J.C. Penney Co. Inc. has made “significant” progress since Myron “Mike” Ullman 2nd’s return as chief executive officer nearly two years ago, but will need to step up its game if it’s to meet the upbeat projections — and substantial debt maturities — awaiting ceo-designee Marvin Ellison.
According to a study by Scott Tuhy, vice president and senior credit officer at Moody’s Investors Service, Penney’s outlook for growth in sales and profitability over the next five years, laid out at an October Investor Day, tends to err on the side of bullishness, beginning with sales plans that call for annual growth of 5.7 percent to reach its goal of $14.5 billion in revenues, from $12.26 billion last year, and on which its profitability goals are based.
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“It has only managed to achieve this [sales growth] once, in 2005-2006, when consumers went on a debt-fueled spending binge,” Tuhy wrote.
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Moody’s believes that sales growth is more likely to be about half as rapid — 2.7 to 2.8 percent — in the next few years, which would still exceed its “average growth for seven out of the past 11 years,” even when weak results from the 2008-2009 fallout and the sales contractions under former ceo Ron Johnson in 2012 and 2013 are excluded.
He backs up his skepticism by noting that some of the “easy gains” to be gleaned in the post-Johnson era, such as the reintroduction of St. John’s, have already been accomplished. Nor does Tuhy expect any letup in the market share gains of numerous competitors, from fast-growing off-pricers and fast-fashion specialty stores to the direct-to-consumer expansion of many brands, all of which have further pressured midtier department stores.
“We did not see any meaningful evidence that JCP’s mall and off-mall competitors — like Macy’s, Bon-Ton, Dillard’s or Kohl’s — were beneficiaries of JCP’s more than $5 million decline in sales during 2012 and 2013,” he said of the firm’s 31.3 percent sales erosion from 2011 to 2013.
“I think Penney’s did pretty well under the circumstances last year,” Tuhy told WWD. “They did improve their [earnings before interest, taxes, depreciation and amortization] by $1.1 billion and, at 4.4 percent, post one of the better comps in the industry, but they were up against the easiest comps of just about anybody.”
Despite a 2 percent comp gain in the final quarter of 2013, the figure for the full year was a 7.4 percent decline.
Whereas Penney’s expects its EBITDA before pension expense to reach nearly $1.2 billion in 2017, Moody’s, drawing on its best-case scenario, expects adjusted EBITDA to reach $800 million that year. The $1.2 billion goal is expected to require “at least four years.”
While Moody’s thinks that even its $800 million projection “will be sufficient to cover interest expenses and its capital structure,” it noted that the 2014 unadjusted EBITDA figure — $323 million — wasn’t sufficient to cover its net interest expense of $406 million.
Its ability to generate cash and profit is under less pressure now because it is facing modest debt maturities — none this year, $80 million next year and $220 million in 2016, all of them involving unsecured debt.
That changes somewhat drastically when maturities rise to $2.44 billion in 2018 and $875 million in 2019. Of those amounts, $2.14 billion of the 2018 figure and $475 million of the 2019 total are secured against the company’s inventory and real estate assets. Tuhy considers the $300 million in maturities through 2017 “manageable” and the secured portion of the 2018 and 2019 amounts relatively easy to deal with based on the Plano, Texas-based retailer’s real estate portfolio, but he expressed concern that the $700 million in unsecured debt maturing “could be more challenging to refinance if earnings don’t significantly improve.
“They certainly have time,” Tuhy said, “and being able to borrow on a secured basis should keep interest expense down, and they do have the distinct advantage of owning real estate.”
To elevate its corporate credit rating — currently at “Caa1,” meaning its obligations are subject to “very high credit risk” — Moody’s would need to reduce its debt-to-ebitda ratio, currently at 13.8, down to the “mid-6” area.
Tuhy considers top-line growth key to any improvement in Penney’s financials and said that it needs enhancements, such as the 2006 addition of Sephora shops, “to drive additional traffic.”
“To drive outsize growth, we believe J.C. Penney would need — in simple terms — another Sephora,” he said.