Big box retailers have fallen into pretty hard times lately, but iconic American retailer J.C. Penny is simply becoming unraveled. Its bonds are really coming apart now.
J.C. Penny has been around for a very long time now, first founded by James Cash Penney and William Henry McManus back in 1902. The company has seen and survived a lot over the last 117 years, but this all appears to be very likely to be coming to an end soon.
Penney has been one of America’s leading retailers all these years, and still maintain a pretty big footprint, even though they have closed quite a few stores over the last couple of years. They still have over 800 left, but this amount might be quite a few too many given how the company is doing.
The goal of any business is of course to make money, not lose it, and you can only lose so much for so long without the walls eventually caving in. J.C. Penney has not had a profitable year since 2011, and since then has lost a total of $3.76 billion, a simply enormous amount relative to their market cap these days of only $300 million.
We may say that a stock has been hammered if it loses 50%, 60%, or 70% of its value, but this company’s stock losses dwarfs any of that. Since 2007, this stock has lost a cool 99%, where it has fallen from over $85 a share to only 80 cents a share on May 29, and is now only barely over a dollar.
This can only be described as a massacre, but when you lose this much money over 7 years and there still isn’t any good reason to think that the company will survive for much longer, that really should not be surprising.
Penney’s Bonds Sink Much Further into the Mud
A month ago, bond markets were pricing in its likelihood of default over the next 5 years at 88%, but this has now jumped to 95% after yet another downgrade and more and more concerns about their having enough liquidity to keep the show running.
Moody’s, who downgraded them to Caa1 on May 31, did mention that it is not really that concerned with J.C. Penney’s liquidity right now, but the bond market sure is. They do have a little cash and access to $1.7 billion with a line of credit that doesn’t come due until 2022, but there are concerns that suppliers may pull the rug out from under the normal short-term financing that retailers customarily receive, and they are also buying insurance against Penney’s defaulting on these short-term financing arrangements.
This really spells trouble as if they can’t keep their inventory up, this will bring down the whole house of cards in very short order. This would simply ruin them financially because this would certainly spell the end of their credit rating altogether, and when you are losing money at the rate they are, borrowing more and more is your only lifeline.
However, while we might be alarmed at suppliers buying insurance, this does tell us that this is not likely at all, as they have found a way to manage this risk. It’s hard to say no to a big sale, and as long as the cost of insuring the risk isn’t too high, and it does not appear to be at all now, then there is no real problem yet.
There are even concerns about their making the $50 million bond payment due in October, although there really does not seem to be much of a threat of that not happening, given they can still tap into that big line of credit. When the line of credit matures though, that may be a different story, but the real problem is that you can’t just keep borrowing forever, and when your credit dries up, the game is over.
Meanwhile, the price of their bonds is plummeting, and as the price falls, the yields go up. Yields on one-year bonds are now at a very alarming, and perhaps even tempting 33%. You can now bet on their lasting just one year and get that much of a return for your bet, and in spite of this company hanging off a ledge and about to fall upon the rocks, they very likely won’t be losing their grasp this soon.
Even the bonds that are due in October are now paying 15%, and this one looks even more in the bag, and it’s actually hard to imagine their defaulting this soon on such a relatively small amount. All we are shooting for when we hold corporate bonds is the company not defaulting, and since paying bond redemptions is at the top of the list, ahead of anything else, this does look like an easy 15% return at this point, and like the 33% one-year, the risk here looks very overpriced.
Bond markets usually don’t overprice risk anywhere near this much, and this may be an opportunity that doesn’t come around very often. Some hedge funds love distressed companies, but for some reason these bonds are scaring off investors in a way that does not even seem to make much sense given these crazy yields.
As Bad as This Stock Is, Penney’s Short-Term Bonds May Not Be So Bad
As far as the company’s stock goes, there is not a lot to get excited about to say the least, with its price being nuked with very little reason to hope that it can come back very much. If you bought it here and it went to just $2, still a pittance compared to where it has fallen from, you’ve just doubled your money, but this bet doesn’t look like it is likely to succeed at this point and the risks involved are very substantial.
The biggest knock on J.C. Penney is its customer service, which is seen as simply atrocious and they consistently earn just one star out of 5. The Better Business Bureau gives them an overall rating of 1.08 out of 5 and poor customer service is cited as the reason. If you could go below 1 on this scale, J.C. Penney would, as a 1 here really means zero.
They just hired a new executive VP of Customer Experience, so they finally may be paying attention, but this may very likely be too little too late. It takes both a lot of effort and a lot of time to turn around a company’s negative reputation, and this company needs to completely re-invent themselves to survive much longer, a task that seems monumental at this point.
We hear all the time about how these retailers are being beat by Amazon, but while online retail has grown a lot over the last few years, it still only represents about 10% of the overall retail market, and 90% of this is still in the hands of the old-fashioned brick and mortar stores.
Walmart is a far bigger culprit here, and are the people that stores like Penney need to be worrying about, although with Penney the biggest culprit may be neglect. If you’re going to compete with Walmart, you can’t do it on price, so you’re left to fight this war with superior service, and Walmart does not really stand out that much here. If yours is far worse though, you have a lot of work to do indeed.
J.C. Penney recently pulled their appliance business, and this will drive down their sales even more. They have cut stores but when you’re still losing money, that should tell you that you have not done enough, and if they do not do more, a lot more perhaps, they will all close soon enough anyway.
This is not a stock that anyone should be wanting to own anytime soon, at least until we see a meaningful increase in their hope of survival. Their fundamentals are terrible and if they don’t stop losing money, this will eventually seal their fate.
Their bonds may present some opportunities for the braver bond investors, although most investors don’t have very good access to them. The bond market is very far behind most other financial instruments in terms of liquidity and tradability. They can still only be purchased in the over the counter market through a bond broker, accounts that very few individual investors have. The combination of needing a separate account, high minimum deposits and fees, and an almost total lack of familiarity with corporate bonds or how one would invest in them outside a fund means few ever travel down this road.
Individual investors are always well cautioned to do their due diligence when considering buying corporate bonds, and not without good reason. While this would seem to especially apply to corporate bonds from companies on their death bed like Penny is, when we see yields this high, the calculations aren’t so daunting.
We can in fact just look at their liquidity, which the company claims won’t go below $1.5 billion over the next year, look at how much they may be expected to lose along the way, add in bond redemptions, and see how much buffer there is. If you get 33% over a year, the break-even point would be a 1 in 4 chance of default, and it does not look like it is anywhere near this high over the next year and may even be pretty close to zero. That might be worth considering actually.