August 2, 2018

JCP Valens Credit Analysis – CDS 1,207bps, Base Case iCDS 314bps, Negative Case iCDS 615bps, 2023 7.125% Bond YTW of 12.384%, iYTW of 5.994%, Caa1 Rating from Moody’s, XO (equivalent to Baa3) Rating from Valens, High Refinancing Need

  • Credit markets are grossly overstating credit risk, with a CDS of 1,207bps relative to an Intrinsic CDS of 314bps, and a cash bond YTW of 12.384% relative to an Intrinsic YTW of 5.994%. Furthermore, Moody’s is materially overstating JCP’s fundamental credit risk, viewing the firm as having substantial default risk, with its Caa1 rating seven notches lower than Valens’ XO (Baa3) rating
  • Incentives Dictate Behavior™ analysis highlights that JCP’s management compensation framework should incentivize them to improve margins and expand revenue over time, which may lead to greater cash flows available for servicing debt. Also, with low change-in-control compensation, management is not incentivized to pursue a sale or accept a buyout of the business, limiting event risk
  • Earnings Call Forensics™ of the firm’s Q1 2018 earnings call (5/17) highlights that management generated an excitement marker regarding their position in the marketplace and structural changes in their organization. Furthermore, management is confident in JCP’s gross margin growth, and improved liquidity position
  • JCP is trading at a 0.9x UAFRS-based P/B, which is low relative to historical valuations. However, even at these levels, equity markets appear to be pricing in a near-best-case scenario for operational turnaround, likely limiting equity upside from operational improvement. That said, because JCP trades at a discount relative to its asset values, potential credit driven equity upside may be warranted
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