Fitch Upgrades J.C. Penney's IDR to 'BBB'; Outlook Stable
Fitch Ratings has raised its ratings of J.C. Penney Co., Inc.'s (Penney) Issuer Default Rating (IDR), senior unsecured notes and debentures, and $1.2 billion unsecured bank facility to 'BBB' from 'BBB-'. Approximately $3.4 billion of debt is affected by the upgrade. The Rating Outlook is Stable.
The upgrade reflects Penney's solid operating momentum and ongoing debt reduction, and the expectation for further improvement in the company's financial profile going forward. In addition, the rating considers the competitive nature of middle market retailing and the potential negative impact on consumer spending from a slowing housing market.
Penney's comparable store sales have been positive over the past five years as the company has employed a consistent strategy designed to update its apparel offerings and refine its assortments to reconnect with its core, middle income customer. Improvements to the company's merchandise offerings and ongoing expense control have led to meaningful improvement in the company's operating margin, which increased to 8.9% in the 12 months ended July 29, 2006 from 7.1% in 2004. Fitch believes there is additional upside to operating margins as the company further refines its merchandise assortments and carefully manages expense levels.
Improved operating margins and positive comparable store sales have resulted in higher earnings and stronger credit measures. Leverage, measured by adjusted debt/EBITDAR declined to 2.5 times (x) as of July 29, 2006 from 2.8x at July 30, 2005, and EBITDAR coverage of interest and rents increased to 4.3x from 3.6x over the same period. In addition, liquidity remains strong, with cash in excess of $2 billion, part of which is earmarked for repayment of debt maturities over the next few years.
Penney has returned to a growth mode, with 28 new stores added in 2006, and 50 new stores planned per year in 2007-2009. The company is expected to generate sufficient operating cash flow to finance higher capital expenditures to support this growth along with significant remodeling activity. The company also intends to continue to repurchase its shares with free cash flow and option proceeds. As a result, Fitch expects Penney's credit measures to further improve over time.
Approximately 80%-90% of the company's planned new stores are in an off-mall format, which will increasingly put Penney in competition with Kohl's, which itself is building 100 stores per year. Penney and Kohl's will be competing for sites and will increasingly compete head to head in new locations, which could make the middle market segment more challenging.
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