JCP Valens Credit Analysis – CDS 967bps, Base Case iCDS 401bps, Negative Case iCDS 722bps, 2023 7.125% Bond YTW of 13.127%, iYTW of 6.957%, B3 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 967bps relative to an Intrinsic CDS of 401bps, and a cash bond YTW of 13.127% relative to an Intrinsic YTW of 6.957%. Furthermore, Moody’s is materially overstating JCP’s fundamental credit risk, viewing the firm as a highly speculative, high-yield credit, with its B3 rating six 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 grow 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 Q4 2017 earnings call (3/2) highlights that management is confident in their planned product launches and brand expansions for Sephora in 2018, and that their Jewelry business is strong online as their assortment meets different customer needs. Additionally, they are confident that their speed calendar allows their merchants to make decisions closer to the time that merchandise has to be on the floor
• JCP is trading at a 0.9x UAFRS-based P/B, which is low relative to historical valuations. However, equity markets appear to be pricing in the 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, credit driven equity upside may be warranted