Summary
Vendors could become the key factor in forcing an in court restructuring within a year.
Even with a large line of unused credit JCP could still file for bankruptcy.
New management may throw in the towel and start with a clean slate.
Additional stores could close.
I think that J.C. Penney (JCP) could file for Ch.11 bankruptcy sooner than I expected. In May 2017, I wrote an article about why JCP would eventually file for bankruptcy and when. I thought the payments for maturing debt would influence their final decision and expected them to file for bankruptcy in June 2020 when about $400 million in notes were due. Vendors are now the problem that could cause a liquidity crisis and force a bankruptcy filing within a year. New management may be willing to clean the slate and start fresh after a Ch.11 filing.
Vendor Problem
While I always thought that problems with vendors would be a problem for JCP going forward, the vendor issue is about to become more acute because of the bankruptcies of Sears Holdings (OTCPK:SHLDQ) and Toy «R» Us. Under the Toys «R» Us plan (docket 4491), vendors are getting only about 22% recovery. In an attempt to protect their interests, over 60 vendors have filed demands for reclamation of goods from Sears under section 546(c) claiming that Sears was «insolvent» as defined by section 101(32) at the time the goods were received.
The goods that were received by Sears within 45 days prior to their October 15 Ch.11 bankruptcy filing are subject to the reclamation demand. As expected, Sears has just ignored these demands and because of the lack of teeth in laws, there is not much vendors can do to reclaim their goods.
If Sears vendors hear indications of only modest recoveries for their unsecured claims under a Sears reorganization plan being negotiated, they may decide that they need to be more aggressive to protect their exposure to a possible JCP bankruptcy and no longer sell to JCP on credit. Even JCP vendors who had no business dealings with either Sears or Toys «R» Us, may put JCP on their “no credit” list and demand being paid prior to or upon delivery.
At the end of the last quarter, they had $1.234 billion in merchandise accounts payable. If more vendors do not extend them credit, JCP would have to draw on its ABL facility because of their low cash position.
Vendors have a problem. For goods received on credit from the vendor more than 20 days prior to bankruptcy are classified as unsecured claims under Ch.11. Unsecured claims have a low priority for getting any recovery. (Goods received within that 20-day window are classified as administrative claims and have very high priority status per section 503(b)(9). So if vendors become increasingly worried about a bankruptcy filing by JCP they may want to be paid first before shipping because they don’t want to receive pennies on the dollar as an unsecured creditor.
There is the possibility that JCP will follow what happened to Toys “R” Us after there was a report by Reuters about hiring Kirkland & Ellis for a possible restructuring. Their CEO stated (docket 20) in his declaration about the impact of this report:
The impact on the Company’s supply chain was fast and furious. Within a week, 40 percent of the Debtors’ supply chain refused to ship product and 10 days later, practically all of the Debtors’ vendors had refused to ship without cash on delivery. The Company lost its access to product during the critical shipping period to build inventory for the holiday season.
Toys «R» Us was effectively forced into filing for Ch.11 bankruptcy within a few weeks after the article.
The timing of when vendors become even more restrictive when dealing with JCP is a function of when it becomes clearer how much the recovery is expected for vendors under a Sears reorganization plan. A low recovery estimate could have a quick and brutal impact on JCP.
(The odd part is that JCP has too much total inventory. In 2013, they had $2.683 million of inventory per store compared to $3.748 million per store now. Of course, prices went up some, but not enough to explain the entire increase.)
Some investors are incorrectly assuming that since JCP has some unused line of credit that it would not want or need to file for bankruptcy. The reality is that companies still file. For example, Peabody Energy (BTU) had over $1 billion in a used revolver. Peabody drew down the remaining amount on its $1.65 billion revolver shortly before filing. They wanted to build up their cash so that they needed a smaller DIP.
Finances
I am not sure if management understands how weak their financial structure is or they are just trying to reassure vendors and customers in a PR type statement, but Trent Kruse stated in the recent conference call, «Do we still feel we have a little too much debt; yes. Are we over-levered? Look, I think it’s more a function of needing to improve the EBITDA.» (They need to reduce debt and increase EBITDA.)
They have too little cash and too much debt as can be seen by trend in the table below
Cash to Debt
| 2017 | 2016 | 2015 | 2014 | 2013 |
| 10.8% | 18.3% | 18.7% | 24.8% | 27.5% |
JCP no longer has a $400 million hurdle in June 2020 that I thought might be the trigger for them to file. They used cash to pay off some of these notes and currently there is about $110 million still outstanding. Instead of using cash, they should have used some type of equity for debt exchange offer when the price of JCP was trading in the $5 range with a high equity amount as strong incentive to participate in the exchange offer. With the stock trading barely over $1 and the exchange offer is off the table. With total debt of 11.4x greater than the market equity capitalization, their options for raising new additional capital is limited.
Even if there is some limited amount of assets that are currently not encumbered, these assets could be used to secure DIP loans in bankruptcy. At some point, it becomes apparent that maxing out all leverage possibilities is not the best strategy. The reality they need to file and deleverage in Ch.11.
Will Sears Customers Now Shop At J.C. Penney?
The expectation by some that JCP will get a huge number of customers from the closing of Sears stores is unrealistic. First, to be direct, JCP is a women’s store and Sears is a men’s store. That may be a simplification, but buying tools, work boots, and work clothes by males has been key part of their business model; while women’s clothes, jewelry, and makeup has been JCP’s. I just don’t see the male shoppers (with their wife/kids) going to JCP as their primary alternative.
Second, Sears has been closing stores for years and there has not been a great shift of customers from those closed stores to JCP stores. In February 2013, there were 2,009 Kmart and Sears stores. Within a few weeks, there will only be about 505. If we follow the logic that customers switch from a closed Sears to an open JCP store, the JCP stores should have already had a huge increase in foot traffic over the last few years – they have not.
Will New Management Throw In The Towel?
The new CEO and CFO have no major SHLDQ shareholdings that would make them reluctant to file for Ch.11. They actually may have an incentive to file because management incentive plans that are part of reorganization plans are often extremely lucrative. If the balance sheet is cleaned-up in bankruptcy, management can focus more on improving EBITDA without the constant worry about weak finances.
I think new management wants to start with a clean slate and will be willing to file with the expectation that they will be getting a nice MIC when JCP exits Ch.11.
Latest News
The latest quarter indicated that problems are getting worse – not better. Comparable store sales decreased 5.4%. For more detailed analysis of the third quarter read this article by Elephant Analytics. What I find interesting is that there was no mention of appliances in the report or in the conference call. (One has to wonder if appliances are on the table to be eliminated in yet another business model formatting by the new CEO.)
There also could be more store closings as Trent Kruse stated “We’re in the process of reviewing the store fleet as we do on an ongoing basis… and updating you at the end of this year on our thoughts surrounding that.”
They may need to retain some outside consultants to help them determine if it is better to close additional stores now or wait and close them under certain benefits Ch.11 provides. Hopefully, they will negotiate a restructuring support agreement prior to filing.
Conclusion
J.C. Penney has a total of $10.58 in losses per share from 2013 through the last quarter and this was during a period of strong economic growth in the U.S. They clearly do not currently have a viable business model.
Vendors are getting burned too often with retailers filing for bankruptcy and they could become more aggressive dealing with JCP after they are informed that their recovery under the Sears reorganization plan is low. I think the vendor issue will force JCP to file for Ch.11 within a year.
The stock price has dropped from $4.65 to $1.26 from when I wrote my article in May 2017 recommending investors to sell JCP. I do not expect any recovery for JCP shareholders under a bankruptcy reorganization plan because there are just too many higher priority debt claims. Unlike Sears, I do not expect any potential payment for releases to JCP shareholders, since there have not been any actions by management that could be subject to litigation.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.
Additional disclosure: I am no longer short JCP because of the cost to carry the position
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