J.C. Penney Draws The Last Arrow In The Quiver

Jun.24.14 | About: J.C. Penney (JCP)

Summary

J.C. Penney has had a nice turnaround in the last four months, chances of success are looking better than they have in a while.

Riding high, the company closed a new senior, asset-backed, $2.35 billion credit line to do its business with.

The purpose was to extend the maturity date of its last facility (i.e. buy time) and to pay back a little of its previous debt - ugly.

Caution should still be used when investing here; the company is leveraged horribly.

It certainly has been a great last four months for J.C. Penney (NYSE:JCP). I had a small discussion with another SA contributor yesterday about how neither of us harbored the proper stone size to have bought when the company was trading the $5 range just 4 months ago. For those that purchased that low, they've been handsomely rewarded, as the stock then promptly made its way as high as $10 last month. Penney has now settled down, and seems to be resting on the 200-DMA and 50-DMA for support around the $8.50 level. Still, if you timed it right, an impressive move up.

Click to enlarge

This is in no way a bearish article on Penney, either. This is a piece simply to let people know that the last arrow in the quiver has been drawn, and that caution should be taken around this name. As a public company, there are certain routes you can take to raise money - and certain types of debt that you can bring on that, if not paid back, could spell an issue for the company. The company already tapped convertibles in late 2013 - now it's extending the maturity on its senior secured credit facility.

In mid-May, the retail giant posted a better-than-expected first quarter - although the results weren't exactly amazing compared to the losses the company had been taking on. It reported 6.2% same-store comp growth (against its less-than-stellar comp number). Additionally, the company upped its gross margin rate and cut SG&A costs by $69 million.

That news is what pushed the stock near its six-month highs around $10. After earnings, Wells Fargo came out and downgraded the company due to its heavy debt burden, and dropped the retailer to a $5 price target. Those concerns don't seem too far off, either. The equity left in the company seems to only be the property, plant and equipment. And, those are spoken for too.

ValueWalk reported on yesterday's news of Penney closing a new credit facility:

According to the struggling century-old retailer, it closed a new $2.35 billion asset-based senior secured credit facility consisting of a $1.85 billion revolving credit line and $500 million term loan. J.C. Penney Company, Inc. (NYSE:JCP) said it will use the revolving credit for general corporate purposes and working capital. It will also use the proceeds from the loan to pay down its cash borrowings from the previous credit facility.

The retailer said the $2.35 billion senior credit facility provides better pricing terms and will replace the $1.85 billion facility, which is scheduled to mature in April 2016.

In a statement, J.C. Penney CFO Ed Record said, "We proactively pursued this new facility to extend the maturity several years and further enhance our liquidity position, particularly during periods of peak working capital needs. We are pleased with the improved pricing terms of this facility as well as the support and confidence from our banking partners.

One type of "last-ditch" debt that I was talking about earlier is senior secured debt. Senior debt is basically debt that gets payback preference over creditors and other debtors, should the company go out of business. It's basically one other person that gets in the long line of debt holders and shareholders that would get paid off if the company went bankrupt. Senior debt is usually secured by collateral - which, in the event of bankruptcy, is then sold to repay the senior debt. This leaves junior debt holders way down the pecking order, and common shareholders - well, let's just say they're not likely going to be getting anything if the company goes bankrupt.

It looks like the reason the company took this debt on isn't a good one either - it was to extend the maturity date of its last credit facility, buy the company a couple of years of business, and pay down some of the debt the company has already accrued.

In other words, mom just took out a home equity loan on the house to pay off the credit card bills.

J.C. Penney put out a press release yesterday, and stated:

"We proactively pursued this new facility to extend the maturity several years and further enhance our liquidity position, particularly during periods of peak working capital needs. We are pleased with the improved pricing terms of this facility as well as the support and confidence from our banking partners."

Those that would consider investing in this company at these levels need to take a serious look at the company's balance sheet and realize that the equity in the company is dissipating little by little, while it continues to try and turn around sales. It's truly a race against the clock in the case of J.C. Penney - and even if it does survive, the structure of the company isn't going to be close to what it was in its heyday.

JCP Shares Outstanding Chart

JCP Shares Outstanding data by YCharts

It's not a very scientific-looking chart, but it gets the point across. The company has diluted by about 33% in the last year, and has taken on substantial debt in the meantime.

JCP Net Income (Annual) Chart

JCP Net Income (Annual) data by YCharts

And, even though the company's comps were impressive, the company continues to lose money. Unless that issue can be dealt with efficiently and quickly, there's going to be no fundamentals left for J.C. Penney to protect with its cash pile. Granted, Penney has seemed to have found some success moving back towards its old model of discounted apparel and brands like Levi's and Van Heusen. Additionally, it's opening 30 new Sephora stores inside of its locations - another move that I like. Sephora is an outstanding brand with a massive following.

However, I'm going to need to see a little bit more of the rubber hitting the road in the case of a company with so much debt, before I can get really bullish here. I'll be watching this one from the sidelines, and encourage caution from J.C. Penney investors.

Best of luck.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.