Wachovia analyst sees J.C. Penney entry point if stock falls below $21

By Ronda Fears

Nashville, Tenn., June 10 - J.C. Penney Co. Inc. weakened somewhat last week on ratings downgrades because of the company having to fork over security for a new bank facility. Wachovia Securities convertible analyst Sri Nadesan said a better entry point would be a little lower than where J.C. Penney is right now.

Moody's Investors Service cut the J.C. Penney 5% convertible due 2008 to B1 and senior unsecured to Ba3, shortly after Fitch's downgrade to B+ from BB, due to the retailer granting of security for its new bank facility.

"The convert is trading around the 103 level with the stock at $23.33. The current yield is 4.9% and premium is 25.8%. The bond is about 7% cheap using a 500 bps credit spread and a 40% stock volatility and 110% call threshold, which we think are all reasonable," Nadesan said.

"While the stock did perform very well last year, up 146% in 2001, it has declined 12% year-to-date. The stock is trading at 23.8 times the current year, fiscal 2003 EPS forecast and 14.2 times the fiscal 2004, next year's forecast. While the company has some issues to work through, we think the company's performance over the next few quarters should support the stock at current levels.

"In terms of entry point, while current stock price is not bad there could be an opportunity to buy the convert at a lower price stock price. A good entry point would be with the stock price less than $21."

The Moody's outlook on J.C. Penney's debt is now stable, he noted.

Moody's and Fitch downgraded J.C. Penney because the company had to provide security to finalize the new bank facility and thus the asset and structural protection of the subordinated debt holders has diminished.

"Although we view the provision of security to complete the new facility as a negative, we believe J.C. Penney is showing improvement in its credit profile," Nadesan said in a report Monday.

In fact, he noted, Moody's said it expects J.C. Penney to "improve its profitability and cash flow generation, and that credit metrics will show improvement with each passing quarter."

On May 31, J.C. Penney announced it had completed a three-year, $1.5 billion bank line of credit to replace the facility set to expire in June 2002. To secure the new line of credit, the banks have sought and received security for the facility - department store and catalog inventory.

At the end of fiscal 2001 (Jan. 26, 2002), we understand the inventory at the department store and catalog operations stood at about $2.9 billion, out of a total inventory balance of $4.9 billion.

At last week's renewal of the bank facility, Wachovia believes J.C. Penney had no outstanding borrowings under the old $1.5 billion bank line of credit. The company ended the first quarter (April 27) with about $2.3 billion of cash and short-term investments after paying down about $700 million of short-term debt.

J.C. Penney ended the first quarter with $5.41 billion of debt.

J.C. Penney's total debt, including operating leases, stood at $8.3 billion at the end of the first quarter.

Wachovia estimates J.C. Penney's lease-adjusted long-term debt to EBITDA stood at 4.3 times and interest coverage stood at 2.7 times.

In a weekly sales update Monday, J.C. Penney said June same-store sales through Saturday are running slightly ahead of its forecast for a low, single-digit percentage increase. The company said catalog sales for the month were running about 15% below year-ago levels through Saturday, while same-store sales from its 2,643-store Eckerd drugstore chain are on track for a high, single-digit percentage gain.

J.C. Penney shares closed up 28c to $23.61. The convertible gained 1.25 points to 104.25.

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