Earlier this month, J.C. Penney (NYSE: JCP) reported solid sales and earnings for the fourth quarter of fiscal 2017, following several quarters of disappointing results. Nevertheless, the company still has a lot of work to do to achieve sustainable profitability.
Last week, J.C. Penney bought itself some more time for a turnaround by making moves to refinance more than $300 million of debt that was set to mature in 2019 and 2020. By then, it should be clear if management's sales growth initiatives are working -- or if more drastic measures will be needed to save the company.
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Signs of hope at J.C. Penney
In the first three quarters of fiscal 2017, J.C. Penney's comparable-store sales declined 1% year over year. Furthermore, the company faced severe gross margin pressure as it tried to clear out excess inventory. As a result, it posted a wider loss than in the prior-year period, excluding a big gain from the sale of a distribution center in Buena Park, California.
By contrast, sales momentum returned last quarter, as J.C. Penney started to capitalize on store closures at Sears Holdings (NASDAQ: SHLD) and other rivals. Comp sales rose 2.6%, and gross margin improved year over year.
Better performance in the key apparel segment contributed to these strong results. However, the home category remained J.C. Penney's main growth driver. Comp sales surged nearly 40% for furniture and nearly 60% for mattresses, while appliance sales rose more than 30%. Sears is giving up market share in all three areas, but particularly in appliances, where it was once dominant.
CEO Marvin Ellison believes J.C. Penney has a multibillion-dollar sales opportunity ahead of it, as Sears and other floundering retailers like Toys "R" Us shutter stores. Yet J.C. Penney isn't exactly on solid ground, either. As of last October, it had $4.3 billion of debt, including about $900 million due by 2020. With free cash flow low and volatile, the company was at risk of falling into financial distress if it hit any speed bumps in the next few years.
During the fourth quarter, J.C. Penney repaid the $211 million it had previously drawn on its credit line. It also repurchased $40 million of its senior notes due in 2020. Shortly after the quarter ended, it repaid its $190 million of senior notes maturing in 2018.
However, this reduced J.C. Penney's cash and investments balance to less than $300 million. That's not very much, considering that free cash flow is typically negative in the first three quarters of the year.
Furthermore, even after these repayments, J.C. Penney still had $175 million of debt maturing in 2019 and $360 million maturing in 2020. It also has to make quarterly principal payments of a little more than $10 million on its term loan.
J.C. Penney elected to address its looming debt maturities last week by issuing $400 million of debt due in 2025. It had to pay a steep price, offering an interest rate of 8.625%.
The company plans to use most of the proceeds of this debt offering to fund a tender offer for its debt maturing in 2019 and 2020. It hopes to retire $95 million of its 2019 notes and $225 million of its 2020 notes. The remainder will go toward replenishing J.C. Penney's cash balance.
Transparency would have been nice
Some investors were probably alarmed by the interest rate J.C. Penney is paying to refinance its debt. However, the rate was probably driven up by uncertainty over J.C. Penney's ability to refinance nearly $2 billion of debt that comes due in 2023.
Assuming that the tender offer is successful, J.C. Penney's 2019 and 2020 maturities will be reduced to just $80 million and $135 million, respectively. (The quarterly repayments for its term loan will continue as well.) The company should have no trouble repaying these amounts from its free cash flow. There are no other major maturities until 2023.
Thus, this refinancing gives J.C. Penney a solid five years to return to sustainable profitability. That should be enough time to outlast competitors like Sears that seem destined for bankruptcy.
But while there's a valid rationale for this debt offering, it's frustrating that management didn't give investors any warning. On the fourth-quarter earnings call -- less than a week before the debt offering -- CFO Jeffrey Davis seemed to suggest that J.C. Penney would fund its debt maturities from free cash flow. Clearly, the company was far more interested in refinancing its debt than Davis let on. Now, investors must wonder what else J.C. Penney's management isn't being transparent about.
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