J.C Penney’s ratio of merchandise payables to merchandise inventory has decreased slightly, but hasn’t gone down dramatically like Sears’ has.
J.C. Penney’s bonds are distressed, with the 2023 and later maturities pricing in a significant chance of restructuring.
The 2019 and 2020 bonds appear likely to be paid back, although the 2020 bonds are pricing in around a 20% to 25% chance of restructuring by then.
I believe that Jill Soltau will have until early 2021 to show improved results (consistent positive comps and 35%-plus gross margins) before J.C. Penney considers restructuring.
J.C. Penney does need to show some incremental progress starting in 2019 though, as continuing the negative 5.4% comps and low gross margins from Q3 2018 will accelerate its fall.
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WYCO Researcher recently discussed the potential for J.C. Penney (JCP) to file for bankruptcy within a year due to vendors forcing the issue. This certainly is something to consider and keep an eye on. However, while I believe that J.C. Penney’s bankruptcy risk a few years down the road has increased significantly due to a series of poor results, I think its risk of bankruptcy during the next year is low.
I believe that Jill Soltau will have several holiday seasons to show improved results before J.C. Penney contemplates restructuring. If J.C. Penney starts delivering a series of negative comps in the mid-single digits (similar to Q3 2018) or worse, vendor concerns and the risk of near-term restructuring would probably start to increase though.
Gauging Vendor Concerns
To help gauge vendor concerns about getting paid, I like to check the ratio of merchandise payables to merchandise inventory. If this ratio is going down, it may indicate that vendors are getting more concerned about the company’s ability to pay them and are demanding shorter payment terms or payment in advance or on delivery.
In J.C. Penney’s case, merchandise payables as a percentage of merchandise inventory has been going down slightly over the past couple years, but is still roughly at the same level as in Q3 2014. Vendors appear to be keeping an eye on J.C. Penney’s situation, but aren’t alarmed yet.
| J.C. Penney | Q3 2014 | Q3 2015 | Q3 2016 | Q3 2017 | Q3 2018 |
| Merchandise Payables ($ Million) | $1,289 | $1,453 | $1,493 | $1,342 | $1,234 |
| Merchandise Inventory ($ Million) | $3,358 | $3,669 | $3,691 | $3,406 | $3,223 |
| Merchandise Payables To Inventory | 38.4% | 39.6% | 40.4% | 39.4% | 38.3% |
On the other hand, we can see that the ratio of merchandise payables to inventory deteriorated significantly for Sears Holdings between 2015 and 2017 as its vendors prepared for what appeared to be an inevitable bankruptcy. Sears hasn’t reported Q3 2018 earnings yet, but the ratio of merchandise payables to inventory was down a couple percent year-over-year for Q2 2018.
| Sears Holdings | Q3 2014 | Q3 2015 | Q3 2016 | Q3 2017 |
| Merchandise Payables ($ Million) | $2,431 | $2,295 | $1,556 | $772 |
| Merchandise Inventory ($ Million) | $6,464 | $6,208 | $5,032 | $3,452 |
| Merchandise Payables To Inventory | 37.6% | 37.0% | 30.9% | 22.4% |
This metric is something to continue to monitor for J.C. Penney to see if it starts changing rapidly.
Bond Prices
J.C. Penney’s bonds also currently appear to indicate that there isn’t a huge amount of concern about its 2019 bonds getting paid back, although the level of concern starts increasing significantly with subsequent maturity dates.
The table below shows J.C. Penney’s bonds and their current prices and yields to maturity. It doesn’t include J.C. Penney’s $2.03 billion (as of Q3 2018) in secured credit facility and term loan debt that matures in 2022 and 2023.
| Type | Outstanding ($ Million) | Maturity | Price | YTM (%) |
| 8.125% Unsecured | $50 | Oct 2019 | 96.0 | 13.4 |
| 5.650% Unsecured | $110 | June 2020 | 83.0 | 19.3 |
| 5.875% First Lien | $500 | July 2023 | 83.3 | 10.6 |
| 7.125% Unsecured | $10 | November 2023 | 58.1 | 21.2 |
| 8.625% Second Lien | $400 | March 2025 | 59.3 | 20.4 |
| 6.900% Unsecured | $2 | August 2026 | 41.2 | 24.0 |
| 6.375% Unsecured | $388 | October 2036 | 38.0 | 18.2 |
| 7.400% Unsecured | $313 | April 2037 | 37.5 | 20.7 |
| 7.625% Unsecured | $500 | March 2097 | 37.8 | 20.1 |
The 8.125% unsecured notes due October 2019 are currently trading at fairly close to par (96 cents on the dollar), indicating that the market believes these notes are quite likely (90%-plus) to be paid back.
Beyond that 2019 maturity, the bonds become increasingly distressed. The 5.65% unsecured notes due June 2020 notes are trading at a noticeable discount to par (at 83 cents on the dollar), although I would say that still prices in a 75% to 80% chance that the notes get paid back in full.
Once you get to the 2023 and beyond maturities, there’s a large chance of default priced in, with the first lien notes offering a 10.6% yield to maturity and the small 7.125% unsecured maturity due 2023 trading at only 58 cents on the dollar.
Timelines
I believe that J.C. Penney will probably get three holiday seasons to show positive results under Jill Soltau. Not much is expected this upcoming holiday season since it’s too early for Soltau to have a noticeable impact on results.
By early 2021, there should be a pretty clear picture about whether Soltau make enough of a difference at J.C. Penney for it to continue surviving. If the results aren’t there by that time, J.C. Penney may consider restructuring ahead of its 2022 credit facility maturity and its 2023 term loan and first-lien note maturities.
If J.C. Penney hasn’t demonstrated a series of improved results by 2021, then there wouldn’t really be time for another CEO to take a crack at fixing J.C. Penney before those debt maturities. Without some improvement in results the secured debt maturities would also probably be difficult to refinance now, given the 10.6% yield-to-maturity on the first-lien notes.
Improved Results
I think that what would count as improved results would involve J.C. Penney getting gross margins back up to the 35%-plus range and also delivering a string of positive low-single digits (with generally at least +1%) comps quarters. The string of positive low-single digits comps results is similar to what department stores such as Macy’s (NYSE:M), Kohl’s (NYSE:KSS) and Nordstrom (NYSE:JWN) have demonstrated over the last four quarters as they’ve recovered. J.C. Penney on the other hand has not been able to string together more than a couple quarters in a row with +1% or better comps since 2015.
If J.C. Penney is able to achieve this, then it may be able to get EBITDA back up to the $800 million-plus range without the benefit of real estate sales, giving it an opportunity to refinance its 2022 and 2023 debt maturities.
Conclusion
J.C. Penney’s prolonged struggles with sluggish sales growth and inventory management issues have shaken confidence in its long-term survival. Its bonds from 2023 onwards are priced for a significant chance of restructuring. That being said, I believe that it will get several holiday seasons to see if Jill Soltau can improve its results.
It has a limited amount of debt maturing before 2022, and plenty of liquidity. The ratio of merchandise payables to merchandise inventory has only gone down slightly as well, indicating that its vendor situation hasn’t significantly deteriorated yet.
That ratio is something to keep an eye on though, especially if J.C. Penney’s comps don’t improve from Q3 2018 levels.
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Disclosure: I am/we are long JCP.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
