J.C. Penney Company, Inc.'s Next Cost-Cutting Target: Interest Expense

By Markets Fool.com

Ever since J.C. Penney's near-death experience a few years ago -- when a failed strategy shift led to spiraling losses -- the company has been saddled with a high debt load. As a result, J.C. Penney has been incurring more than $400 million in interest expense annually. That's a cost the retailer can ill afford as it tries to return to sustainable profitability.

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In the past year or so, as J.C. Penney's free cash flow has improved, it has started taking steps to reduce its interest burden. Last week, the company announced another big development in that regard, as it is looking to refinance a $2.25 billion term loan issued in 2013, nearly two years ahead of its maturity.

Paying down debt, bit by bit

J.C. Penney started reducing its debt load in earnest last fall. As it put the finishing touches on a second consecutive year of positive free cash flow, J.C. Penney paid off a $500 million asset-backed loan last December. At the same time, it increased the size of its revolving credit line by $500 million, keeping its liquidity intact. Management stated that these two transactions would reduce annual interest expense by about $20 million.

Coming into 2016, J.C. Penney CFO Ed Record said the company hoped to pay down $400 million-$500 million of debt this year. Part of this would be funded by the expected sale of J.C. Penney's headquarters complex in Plano, Texas.

J.C. Penney is working to reduce its debt load.

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The company got started in Q1, as it repurchased and retired $60 million of its debt. This left it with $4.7 billion of outstanding debt.

Looking for more interest savings

It's somewhat surprising that J.C. Penney is already looking to refinance its 2013 term loan rather than waiting until 2017 or early 2018. However, the refinancing plans may be an indication that J.C. Penney thinks it will get a lower interest rate because of its improving credit profile.

As of April 30, J.C. Penney had $2.19 billion outstanding under the term loan. It's only seeking to refinance $2 billion, according to James Passeri of The Street. That alone could save the company about $10 million in interest expense annually, based on the term loan's interest rate of LIBOR plus 5.0%.

Furthermore, J.C. Penney has received B1 and B+ ratings for its new debt offering from Moody's and S&P, respectively. That would be up one notch and up two notches, respectively, compared to the ratings it received for the current term loan back in 2013.

From a qualitative perspective, it also seems plausible that lenders would offer J.C. Penney a lower interest rate this time around. Three years ago, the company was floundering, with sales and earnings both declining rapidly. Today, J.C. Penney has delivered two straight years of positive free cash flow and is on pace to post further free cash flow growth in 2016.

Additionally, the new loan will be backed by real estate with an appraised value of $3.1 billion, further reducing lenders' risk. If J.C. Penney can reduce the interest rate on its term loan by just 0.5 percentage points, it would save another $10 million annually.

More debt reduction on the horizon

In addition to this debt refinancing, J.C. Penney plans to pay off $78 million of high-cost debt maturing in August. In early 2017, it will have the opportunity to retire $220 million of debt that carries a hefty 7.95% interest rate.

In total, these moves could reduce J.C. Penney's interest expense by at least $70 million to $80 million relative to last year's level. That will make a substantial contribution toward J.C. Penney's drive to return to profitability.

The article J.C. Penney Company, Inc.'s Next Cost-Cutting Target: Interest Expense originally appeared on Fool.com.

Adam Levine-Weinberg owns shares of J.C. Penney Company, Inc. The Motley Fool recommends Moody's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.