Fitch Ratings depicted a troubling outlook for J.C. Penney’s (NYSE:JCP) finances. On October 2, the ratings firm downgraded J.C. Penney’s issuer default ratings from B- to CCC because the retailer had burned through much more cash in 2013 than expected.
Fitch is concerned that the projected free cash flow shortfall in 2014 “will require additional external funding,” even though more than $3 billion worth of liquidity has been injected so far this year. The firm now projects that J.C. Penney will burn between $2.8 billion and $3 billion in 2013, $1 billion more than its mid-May projections. That higher cash burn rate reflects Ebitda of -$1 billion to -$1.2 billion compared to earlier projections of -$0.5 billion and higher-than-expected use of working capital.
Beyond 2013, Fitch estimates that J.C. Penney will have to generate a minimum of $750 million to $875 million in Ebitda to fund both ongoing capital expenditures and interest expenses. To generate that sum, the company will have to earn between $13.4 billion and $13.6 billion in sales, or about 14 percent to 16 percent above 2013′s projections, and realize gross margins of approximately 40 percent. “This scenario appears highly ambitious, given the significant execution risk,” Fitch concluded.
As shares of J.C. Penney’s beleaguered stock plummeted nearly 60 percent over the past three months, the word most often following any mention of the century-old department store chain is bankruptcy — or at least a whisper of bankruptcy.
Bankruptcy talk began at the end of September, after Goldman Sachs analysts downgraded the company’s shares based on worries of a growing liquidity problem brought on by the retailer’s ongoing sluggish sales. That announcement spooked investors, especially as emerging data indicated that the company had posted worse-than-expected sales during the back-to-school shopping season, and rumors of the company’s need for more financing ran contrary to the nascent turnaround narrative investors had begun to believe after second-quarter results.
Even though revenue dipped for the ninth consecutive quarter and the company’s quarterly loss widened, same-stores sales declines slowed in the second quarter, dropping just 11.9 percent compared to the first quarter’s 16.6 percent decrease. That metric also improved each month during the second quarter, a pattern J.C. Penney said it expected to continue into the current quarter.
At the time, the fact that same-store sales were on an upward trajectory gave some support to the strategies of Chief Executive Mike Ullman, who decided to use more more coupons and more promotions than his predecessor, Ron Johnson. Analysts took the improving same-store sales — a key measure of retail health — as a sign of life. Belus Capital Advisors chief equities strategist Brian Sozzi told CNN that Ullman had done a good job of selling the turnaround story. “They have a lot more to do, but they threw us a couple bones that confirm they’re not going out of business tomorrow,” Sozzi said.
But even then it was obvious that the retailer would have to slow down its cash burn rate. Early in August, JPMorgan Chase’s Matthew Boss told Bloomberg that J.C. Penney was burning through so much cash that it would likely have to source more outside funds by the end of the year. Still, in its earnings release, the company said given its “current cash position, along with the undrawn portion of its credit facility, the Company expects to end the year with in excess of $1.5 billion in overall liquidity,” including $1.2 billion in cash and $300 million available in its revolver. In a conference call with analysts last month, J.C. Penney executives repeated that they would not need to raise more cash anytime soon.
Then came the Goldman Sachs research. “Weak fundamentals, inventory rebuilding, and an underperforming home department will likely challenge J.C. Penney’s liquidity levels in the third quarter,” wrote analyst Kristen McDuffy in a note seen by Bloomberg. “In order to safeguard against a potentially poor fourth-quarter holiday season, it is likely that management will look to build a bigger liquidity buffer.” As Forbes reported, the note even questioned the company’s future prospects, suggesting that a bankruptcy filing is a possibility.
A good deal of money has already been pumped in to J.C. Penney. Three years ago, activist William Ackman poured $1 billion into the company; then former-CEO Johnson, who oversaw operations for about 15 months beginning at the end of 2011, contributed $50 million. Still, J.C. Penney reported its lowest annual sales since at least 1987 in February. That result proved, as The Dallas Morning News’s Mitchell Schnurman explained, that “writing big checks doesn’t qualify you to reinvent a retailer.”
Johnson, a former Apple (NASDAQ:AAPL) executive who was hand-picked by board member and largest shareholder Ackman, led the company to a 25 percent plunge in revenues, a 50 percent decline in stock price, and a 13 percent drop in customer traffic — solid proof that the makeover he attempted to orchestrate was a failure. In addition to all the cash Ackman and Johnson pumped into the company, Goldman Sachs arranged a $2.25 billion loan earlier this year. That J.C. Penney now has a liquidity problem, as the Goldman Sachs analysis indicated, suggests the retailer is burning through its cash reserves as losses continue to rise.
Just a month after the Goldman Sachs research came Imperial Capital analyst Mary Ross-Gilbert’s analysis. On Monday, she cut her price target on J.C. Penney shares to just $1. “While we think J.C. Penney can be turned around, we are becoming increasingly concerned that without a ‘deep-pocketed’ long-term investors providing financial and ‘halo’ support, the company may strategically file for bankruptcy protection to conserve cash while it continues to execute a turnaround in 2014 and 2015,” Ross-Gilbert wrote in a research note seen by CNN.
J.C. Penny has called the rumors “unequivocally false,” saying last week that they were simply “attempted market manipulation by certain types of investors for their own personal gain.” But even if the rumors of bankruptcy are false, Ross-Gilbert still sees problems, and the continued negative reports are wearing down both vendors and management — that is why she predicts bankruptcy could come in the next year.
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