J.C. Penney debt cut to junk-bond status

Don Hogsett, March 26, 2001

NEW YORK — Moody's Investors Service has slashed its ratings of J.C. Penney debt to junk-bond status, citing "poor operating performance" in its department store and Eckerd drug store businesses, and a weak economic environment that could imperil its turnaround strategy.

Moody's cut the retailer's senior unsecured debt to "Ba2," its second-highest junk grade, from a previous "Baa3" rating. The commercial paper rating was reduced to "Not Prime" from "Prime-3." The ratings outlook after the cuts is "negative," said the credit rating agency. The downgrades affect about $5.4 billion worth of Penney debt.

Beyond the public relations embarrassment, the downgrade will likely make it more difficult for the retailer to raise money, and sharply increase its borrowing costs. It could also trigger a sell-off of Penney by stock mutual funds and pension funds, many of which are restricted from owning junk-rated bonds.

Standard & Poor's, another debt-rating agency, had already cut Penney to its lowest junk-bond rating, "BBB-minus," with a negative outlook.

Moody's said it based the downgrade "on the decline in credit fundamentals given the poor operating performance at its department stores and its Eckerd drug store chain, and an expectation that profitability and credit metric improvements will be difficult to achieve in the near term."

Additionally, saidMoody's, "the difficult competitive environment and the general economic weakness increase the challenge of turning these businesses around. The negative outlook reflects Moody's concern that operating performance could deteriorate further if management is unsuccessful in implementing its strategies for improving its businesses."

Taking note of a two-to-five-year turnaround strategy put in place by new ceo Alan Questrom, Moody's said, "Penney's management is essentially trying to achieve a major change in corporate culture and in merchandising philosophy at the department stores. The long-term, potential benefits are clear." But, Moody's added, "during this time frame there is significant execution risk," and "improvements may not materialize as expected" in a weak economic


Looking at the Penney's big retail and catalog operation, Moody's said, "We expect that the department stores will continue to have negative sales comparisons and low operating profit margins."

Finding something of a silver lining in an otherwise clouded outlook, Moody's said, "While we are not optimistic in the possibility of improved performance in the near term, we recognize that the structural changes that have been made to date by the new management at both divisions are absolutely essential if the company is to be successful in its turnaround. We also recognize that with the announced sale of Direct Marketing Services, and its large cash position, the company has good liquidity to meet its upcoming obligations and fund its working capital needs for the foreseeable future." That cash position, when combined with other hard assets like real estate and drug store receivables, said Moody's, provide "the financial cushion and flexibility that is required as it implements its turnaround strategy."

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