J.C. Penney: So Much Noise, And What The Retail CDS Is Telling Us

| About: J.C. Penney (JCP)

Many SA members have asked me why I follow the bonds and CDS prices so closely on J.C. Penney (NYSE:JCP) and other names. There is an old saw that the participants in the bond market are smarter than the equity market so you want to see what the smart money is doing. In addition, traditionally bond prices tend to lead equity prices down and up for distressed credits.

My own view is that high yield and distressed investors are very smart, but I am not sure they are smarter than the equity investors of the world (think Buffett, Mandel, Loeb, etc. collectively). I do believe that bond investors tend to have better information and that information has a tendency to leak into security prices. For example, if JCP was planning a convert, its investment banker would go out and pre-market the deal. While participants are supposed to be confied up, in the real world that news tends to leak out and the stock would tend to drop ahead of the deal. The same would be true in advance of some kind of debt equity swap. What this all means is that if you see bond prices drop significantly, it could very well signal that the Company has leaked poor numbers to confied up debt holders and that information has leaked into the market even though it shouldn't have leaked in the first place.

What I see in JCP security right now, is a great deal of uncertainty ahead of earnings. The CDS has tightened (bullish), but it is trading actively as people try to hedge and position in front of earnings. the bond prices have firmed but are still trading at distressed levels. Based on this trading action, it doesn't appear that an equity raise is imminent, but it is hard to tell and the Company can always drop another surprise raise. If anything, I would imagine the next liquidity levels will come in the form of second lien debt and drawing on the existing accordion feature of they bank debt. It also pays to remember that the Company actually paid down $200mm of its revolver last quarter which is not the action of a Company about to file.

JCP is in a world of no information and bulls (few) and bears (MANY) debating about whether the Company can get back to some semblance of its former self and generate the $1-2 billion in EBITDA needed to drive real equity value.

What is really driving the stock now ironically, are bearish sell-side equity analysts like Grom at Sterne Agee and Gilbert at Imperial who have been jerking their price targets around. Grom was a former JCP bull who was burned by the Company's raise as he hosted a breakfast for investors just before JCP's equity raise that burned investors who were allegedly told no new equity was needed. Gilbert appears to be jerking her targets around frequently in what look like an attempt to drive bond and equity trading volume.

If you look at the CDS trading of JCP, Sears (NASDAQ:SHLD), Toys "R" Us (TOYS) and Radio Shack (NYSE:RSH). They are all trading at levels that imply bankruptcy very soon. As one CDS trader told me, these companies all better file soon as the cost of carry on these trades is huge.

In the meantime, JCP is getting whipped around ahead of EPS and on no real news.

Disclosure: I am 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.

Additional disclosure: positions can and do change without warning or notice.

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