Penney’s Prognosis: No Crisis, Yet Long-term Viability Uncertain

Questions are being raised whether management can manufacture a strong enough turnaround to insure Penney's long-term survival.

By David Moin
with contributions from Evan Clark
 on July 19, 2019
J.C. Penney store

J.C. Penney Co., with new leadership, a revised merchandising scheme and movement to correct the mistakes of past management, is making a determined bid for survival.

The latest maneuver involves hiring financial advisers to restructure the retailer’s debt.

“As a public company, we routinely hire external advisers to evaluate opportunities for the company,” Penney’s said in a statement Friday. “By working with some of the best firms in the industry, we are taking positive and proactive measures, as we have done in the past, to improve our capital structure and the long-term health of our balance sheet. We have no significant debt maturities coming due in the near term, and we continue to maintain a strong liquidity position.

“Also, given our strong liquidity position we can confirm that we have not hired any advisers to prepare for an in-court restructuring or bankruptcy.”

There’s breathing room. Big maturities don’t come due until 2023, and Penney’s has the wherewithal to cover imminent, smaller debt obligations, including a $50 million payment on Oct. 1. Penney’s had just over $300 million in interest expenses last year, which should hold more or less steady, according to financial reports.

Long-term, Penney’s has $4.1 billion in debt, including a $1.6 billion term loan as well as $500 million in senior secured notes due in July 2023. That seems well into the future, but refinancing takes time and debt investors would want to see some kind of track record of turnaround before betting anew on the company.

On the other side of the ledger, Penney’s owns over 400 store properties, said to be worth an estimated $3 billion to $4 billion in total. The company has 847 stores and six distribution centers.

Penney’s appears to be more flat-lining than growing or collapsing, and must rev up revenues, widen margins, refresh its aging stores and develop new merchandise programs, in addition to covering its debt. It’s slated to close 18 stores in 2019, on top of the hundreds closed over the last several years. Significant changes implemented by Jill Soltau, Penney’s chief executive officer, such as cutting costs as well as dropping major appliances and furniture from stores but continuing furniture online, should improve margins.

“Right now we are supporting Penney’s,” said a major supplier to the retailer and other major department stores, who requested anonymity. “We are comfortable with them. We like the new management team. Jill is not living in denial. She knows the issues. She’s been correcting the mistakes made by Marvin,” the source said, referring to Marvin Ellison, the former ceo who left in July 2018 to run Lowe’s.

“Jill has hired some really good people from Target and Walmart,” said the vendor source on Friday. “But they need more traffic in their stores. They’ve been dropping comps, and online they have been lagging. Penney’s needs more reasons like they have with Sephora to become a strong destination. They need to do more [collaborations] like Kohl’s is doing with Amazon,” the source said, referring to Kohl’s stores doubling as pickup points for Amazon orders and returns.

“I believe JCP is fine this year — likely next year, too,” said William Susman, managing director of Threadstone Advisors. “The real question is the future. Soon we need to hear about the vision and strategy to restore growth, higher margins and greater customer engagement. Others like Kohl’s are trying new things. Penney’s needs their own new initiatives. Store closures are always a positive. But I would ask if JCP is doing enough fast enough. It’s important to stay ahead of any issues. Today’s OK store is tomorrow’s negative cash flow door.”

There have been financial reports suggesting Penney’s debt is “untenable,” and the company’s stock and debt prices keep dropping. External forces exacerbate the situation, like recent retail bankruptcies such as Sears Holdings, as well as potential increased tariffs.

According to Cowen research, Penney’s sources 30 percent of its merchandise from China, while Macy’s is at 25 percent and Kohl’s and Nordstrom are each at 20 percent. Soltau recently said that Penney’s has been “proactive developing contingencies for sourcing our private brands for the better part of the last several years and meaningfully diversifying our country of origin. This has allowed us to significantly reduce our exposure to China, which is already lower than industry averages.”

Since the disastrous, short-lived tenure of Ron Johnson — he ran Penney’s from November 2011 to April 2013 — subsequent teams led by Myron Ullman III and Ellison have worked to stabilize the business, though clear signs of a turnaround are still lacking.

Ellison, who ran Penney’s from 2015 to 2018, exuded leadership and had some fresh ideas. In retrospect, they were the wrong ones. The appliances he brought in looked good on the selling floors but consumers wouldn’t go to Penney’s first for a new refrigerator or washing machine. Ellison, a retail operations executive rather than a merchant, was also criticized for not moving fast enough to improve the apparel side of the business, though additional activewear, casual and special sizes were merchandised, and toys were added to the assortment.

Debt watchdogs have kept a close eye on the company, marking its tenuous financial positioning.

Standard & Poor’s cut its rating on the retailer to “CCC-plus” in March, indicating that the firm’s debt is “vulnerable to nonpayment and is dependent upon favorable business, financial and economic conditions.”

S&P analyst Andrew Bove, in his downgrade, illustrated the challenge Penney’s faces beyond financing. “Prior poor inventory management, underinvestment in omnichannel capabilities, and years of inconsistent brand messaging have created an unappealing shopping experience that has translated to persistent traffic declines. Management must avoid self-inflicted operational missteps and successfully create an industry niche for J.C. Penney within the next two to three years to be a viable business in the long term if it is to repay its debt obligations in full.”

Stock investors, more reactive than debt investors by nature, have become increasingly skeptical of the company, hitting its market capitalization hard. Shares of Penney’s dropped 16.6 percent to 90 cents Friday on the report of a debt restructuring, leaving it with a market capitalization of just $285.5 million. That’s less than one-tenth of the $3.5 billion the company’s stock was worth in August 2016.

Sales at the Plano, Tex.-based department store chain reached $11.66 billion in 2018, versus $12.55 billion in 2017 and are projected dipping under $11 billion for 2019. During the Johnson debacle, Penney’s lost about a third of its volume.

“Soltau inherited a big debt and a losing market share, but she is starting to get the cost structure down, and I believe the store is starting to gain some traction on the top line,” said Craig Johnson, president of Customer Growth Partners. “It helps to have a team in place and it’s a good crew of people. Restructuring the debt is a sound move, too, but the company should have have been working on it sooner.

“I give Penney’s a shot at the future but it’s not a slam dunk or a layup,” he added. “Penney’s is still a great brand. People in Middle America still like the brand, but it’s in serious straits.”

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