J.C. Penney (NYSE:JCP) announced more details about its refinancing plans, offering $500 million in secured notes that have a 5.875% interest rate and are due in 2023. This is in conjunction with a new $1.688 billion secured term facility and results in no change in outstanding debt. This is a modestly positive move that helps reduce J.C. Penney's interest costs by nearly $10 million per year and takes care of a larger nearer-term debt maturity. J.C. Penney's decision to refinance nearly two years before maturity is not unusual and probably makes sense given the need to redo the collateral with the imminent headquarters sale/leaseback.
Secured Debt Rates
The $500 million fixed rate notes have an interest rate that is currently slightly higher than the LIBOR +450 to +475 basis point with a 1% LIBOR floor variable interest rate term loan that was discussed before. The fixed rates notes do reduce the interest rate risk for J.C. Penney on that $500 million in debt though.
The senior secured term loan should have a similar or lower current interest rate than the secured notes as they are equally ranked, with the term loan having a variable interest rate. Micron recently offered 7.5% secured notes while entering into an agreement for a secured term loan at LIBOR + 600 basis points. I'd expect J.C. Penney's secured term loan to come in at around LIBOR + 450 basis points.
The net effect is that J.C. Penney will likely save close to $10 million per year in interest costs. This is a bit less than what I calculated before, since the prior discussion was around a reduced term loan size, while the total debt is unchanged now.
Good Or Bad News?
There has been some discussion about whether the refinancing was good news or bad news. I'd consider it modestly good news. Interest costs go down, debt levels remain unchanged and a major portion of J.C. Penney's debt maturities are pushed back. While J.C. Penney does need to reduce its overall debt, I think that will probably happen through the repayment of the other near-term maturing notes.
Although refinancing the term loan was not expected to be problematic, it is good practice to take care of large debt maturities well in advance. For example, Norwegian Cruise Lines recently refinanced its senior secured credit facility nearly two years in advance of its May 2018 maturity date, extending the maturity by three years and saving a few million per year in interest costs. In J.C. Penney's case, it is extending debt maturities by five years while saving nearly $10 million in annual interest costs.
Bank of America Merrill Lynch mentions that debt is typically refinanced 15 to 18 months before it matures, and recommends that debt is refinanced at least 18 months before maturity in case the credit markets get temporarily closed off, as has happened in times of crisis before.
I also figured that I'd look at the impact of appliance sales briefly here. J.C. Penney mentioned that appliance sales added low-single-digit comps to the pilot test stores. It is rolling appliances out to over 500 stores, which represents roughly half of its total stores. If the results from the pilot test hold, appliances could add approximately 1% to 2% comps to J.C. Penney's overall sales, or around $125 million to $250 million in sales. Gross profit margins are only around 20% for major appliances, so J.C. Penney's gross margin may fall 20 to 40 basis points over the full year once appliances are rolled out nationwide. The net effect is beneficial to EBITDA though, since the products the appliances replaced only had 10% of the sales productivity of the appliances. Therefore, appliances may boost EBITDA by $20 million to $40 million per year with nationwide rollout.
J.C. Penney's debt refinancing appears to be a modest positive as it saves nearly $10 million in interest costs per year. The timing of the refinancing (23 months before maturity) doesn't appear to be particularly unusual as debt is typically refinanced 15 to 18 months before maturity, with a recommendation for 18+ months. I think that the need to change up the collateral for the term loan due to the upcoming headquarters sales/leaseback probably prompted a June refinancing as opposed to waiting until the fall. J.C. Penney's credit rating was not likely to change after one more quarter of results anyway. The refinancing doesn't reduce J.C. Penney's debt, although I'd assume that its remaining near term maturities will be repaid via cash flow rather than refinanced.
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Disclosure: I am/we are long JCP.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.