JCP - Valens Credit Report - 2018 11 27
Credit markets are grossly overstating credit risk, with a CDS of 3,500bps relative to an Intrinsic CDS of 487bps, and a cash bond YTW of 22.940% relative to an Intrinsic YTW of 7.740%. Furthermore, Moody's is also overstating JCP's fundamental credit risk, viewing the firm as having substantial default risk, with its Caa2 rating three notches lower than Valens' HY2 (B2) rating.Fundamental analysis highlights that although the combination of JCP's cash flows and expected cash build will fall short of meeting all obligations, including debt maturities starting in 2020, flexibility in their maintenance capex should allow them to service such obligations in that year. However, it is unlikely they could reduce capex by enough to service all obligations into perpetuity, and they will likely need to refinance by 2023, when the firm faces a $2.1bn debt headwall. That said, given their moderate 70% recovery rate on unsecured debt, the firm should have access to credit markets to refinance if operations don't significantly improve.
Incentives Dictate Behaviorâ„¢ analysis highlights that JCP's management compensation framework holds mixed signals for credit holders. Management's compensation framework should incentivize them to improve margins and expand revenue over time, which may lead to greater cash flows available for servicing debt. Also, management receives low change-in-control compensation compared to their average annual compensation, implying that they are not incentivized to pursue a sale or accept a buyout of the business, limiting event risk. However, a lack of focus on asset efficiency and leverage in the compensation framework suggests management may overspend and overleverage the firm's balance sheet in order to finance growth. Moreover, members of management are not material holders of JCP equity relative to their annual compensation, implying they may not be well aligned with shareholders for long-term value creation.
Earnings Call Forensicsâ„¢ of the firm's Q2 2018 earnings call (8/16) highlights that management is confident that there are opportunities for them to improve their gross margin, and in their ability to meet their SG&A cost targets. Additionally, they are confident in their ability to drive sustainable growth in their digital channel. However, they may lack confidence in their ability to significantly reduce their inventory during H2 2018, and ability to identify new trends and customer insights. Moreover, they may be concerned about their media mix as the holiday season begins, and may lack confidence in their ability to enhance their Women's Apparel assortment. Furthermore, they may be exaggerating their focus on absolute inventory levels, and may lack confidence in the opening of their new store in Brooklyn.
JCP's capex flexibility and moderate recovery rate indicate that credit markets and rating agencies are overstating credit risk. As such, a tightening of credit market spreads and ratings improvement are likely going forward.
J. C. Penney Company is a holding company whose principal operating subsidiary is J. C. Penney Corporation, Inc. The company's business consists of selling merchandise and services to consumers through its department stores and its website at jcpenney.com. The company's department stores and website serve the same type of customers, its website provides the same mix of merchandise as its store assortment along with other extended categories that are not provided in store, and its department stores accept returns from sales made in stores and via its website. The company sells family apparel and footwear, accessories, jewelry, beauty products through Sephora inside JCPenney, and home furnishings.
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