J.C. Penney: Financial Picture Update

Another famous retailer – J.C. Penney – has been back in the news since Reuters announced on July 18, 2019 the hiring of restructuring advisors. We added the retailer to our Worry List on the news. Now Motley Fool has provided a useful summary of the company’s financial condition. Here are highlights: ”

“As of the end of last quarter, J.C. Penney had $3.9 billion of debt, plus another $1.2 billion of lease liabilities. Meanwhile, the company’s adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) has plunged in recent years due to strategic missteps and tough business conditions. This has driven J.C. Penney’s leverage to unsustainable levels. Adjusted EBITDA totaled $568 million in fiscal 2018 — down from $1 billion in fiscal 2016 — putting J.C. Penney’s leverage ratio at more than seven times EBITDA. For comparison, most investment-grade companies have debt that is no more than three times EBITDA”.

The real problem is looming farther out. J.C. Penney has about $2.5 billion of secured debt that will mature between 2023 and 2025. It also has $1.2 billion of unsecured debt maturing between 2036 and 2097. J.C. Penney needs to whittle down the principal balance of this debt while ensuring that it can extend the maturities of what remains.

J.C. Penney’s unsecured debt maturing in 2036 and beyond currently trades for between $0.23 and $0.26 on the dollar. Even some of its lower-priority secured debt trades for less than $0.50 on the dollar. Thus, the market is already factoring in a substantial likelihood that creditors won’t be repaid in full. This should motivate them to cooperate with the company’s efforts to restructure its debt. It might even make sense to write off some of the principal if J.C. Penney can offer more collateral in exchange (and perhaps some equity warrants to reward creditors if the company manages to turn itself around).

From a BDC perspective, the exposure is modest at $3.3mn,  and spread over three FS KKR non-traded BDCs: FSIC II, FSIC III and FSIC IV in two different loans/notes, one maturing in 2020 and another in 2023. We expect lower valuations will be applied in future quarters than as of 3/31/2019 when FMV was close to par, but the impact on individual BDC balance sheets and income statements, even if Chapter 11 does eventually occur, should be modest.