Here’s the good news: J.C. Penney appears to at least understand that it has entered the endgame.
But Myron E. Ullman III, reinstalled as chief executive last week, now has to show how he’s going to win it.
His first big move occurred on Monday, when J.C. Penney said in a statement that it had borrowed $850 million from a credit line that makes a total of $1.85 billion available to the company.
For all its woes, the retailer’s operations have until recently produced reasonably robust cash flows. And at the end of January, J.C. Penney had just over $900 million of cash in hand.
Therefore, the decision to tap its loan now, rather than wait till later in the year when the company’s cash use spikes, suggests that the J.C. Penney has had a particularly bad start to the year. Customers haven’t responded well to brash changes instituted by Ron Johnson, the previous chief executive. Sales have been slumping for months.
And another piece of news in Monday’s statement could deepen the cash concerns. The company said that, in addition to tapping its credit line, it was looking into other ways of raising money.
Though this may seem like desperate moves, there are good reasons to undertake these measures: J.C. Penney’s executives are wisely taking pre-emptive steps to avert the sort of panic that has felled many a retailer.
When a department store company faces financial problems, suppliers get nervous and demand that they get paid for their goods much more quickly - or even upfront. This can reduce cash balances at the retailer, in turn prompting suppliers to demand even stiffer payment terms. Eventually the spiral can lead to bankruptcy. Witness what happened to Circuit City, which collapsed four years ago.
It doesn’t have to end like that, though. There are instances of retailers taking actions to buy time - and quelling the nerves of suppliers in the process. One example is Sears, which last year avoided an aggressive supplier squeeze even though its operations are still faltering.
Fighting panic often has a psychological element, something J.C. Penney’s board and large shareholders appear to grasp. A desire to pacify suppliers, often called vendors in the industry, may also have been behind the departure of Mr. Johnson. “Keeping the vendors happy is key for the company at this point, and that seemed to be a driving factor in the C.E.O decision,†said James Goldstein, a senior credit analyst at CreditSights.
It is also a numbers game.
Having drawn down part of the credit line, J.C. Penney now has an extra $850 million in the bank, at least for now. If it raised another $1 billion from others sources, suppliers might breathe more easily, and the retailer may never need to spend any of the new money. J.C. Penney did not immediately respond to a request for comment.
If J.C. Penney does try other methods to raise new cash, much depends on how it does it. One way is just to sell new shares, which might hurt the already pulverized stock price. But an infusion of new equity could strengthen the balance sheet, since it wouldn’t add to the company’s debt levels.
However, selling a large amount of new stock may be tough, given the pain the stock decline has caused, says Carol Levenson, director of research at Gimme Credit.
“Let’s face it, two major investment firms have already held minority stakes for sometime, Vornado and Pershing Square, and both have lived to regret it,†she said in an e-mail. “Does anybody have Warren Buffett’s number†Vornado Realty Trust is a public company that owns and manages commercial buildings. Pershing Square is a hedge fund run by William A. Ackman.
J.C. Penney could try and raise new cash by selling debt. In that case, it would be intriguing to see what it provides as collateral to the new creditors. On paper, banks already have the right to some assets, like inventory. One option would be to use some of J.C. Penney’s buildings as collateral. Analysts at J.P. Morgan estimate that the retailer’s owned real estate is worth about $2.5 billion.
But there is also a lot of skepticism about how much value can be wrought out of stores owned by struggling retailers. In recent weeks, some analysts said that J.C. Penney could spin off a separate company that would then lease its unused buildings. But Ms. Levenson isn’t convinced by such theories. “Don’t you think if there was something smart to do with Penney’s real estate, Vornado would have thought of it during the past couple of years†she said.
Just about everyone in the retail industry will now be parsing J.C. Penney’s quarterly free cash flows, a metric that looks at how much cash the company’s operations generated after taking into account expenditures on things like new store fittings.
In its latest financial year, which ended in early February, the company had negative free cash flows of $820 million. In the previous year, J.C. Penney had positive free cash flow of nearly $200 million.
But historical numbers won’t be enough. Vendors, shareholders and creditors will also want Mr. Ullman to start detailing how he will try and get concrete improvements in J.C. Penney’s actual operations. That is made especially hard by the fact that the company is in the middle of a transformation that may not work. Therefore, Mr. Ullman has to communicate how far he will go in unwinding Mr. Johnson’s initiatives and reimposing his own. Some of Mr. Johnson’s changes may benefit J.C. Penney, but implementing them can also eat up a lot of cash. And Mr. Ullman’s methods may not be enough.
Ms. Levenson believes J.C. Penney has some time.
She thinks the credit line will provide the company to get through the year, and even allow it to make $800 million of planned capital spending. “During that time, the sales declines could stabilize and perhaps even turn positive, with fresh merchandise, spiffed up stores, and, naturally, more promotions,†she said.
One thing is clear, though: J.C. Penney needs its suppliers to believe in that outcome.
