High-Yielding Troubled Retailer Bonds: Sears Holdings Corporation (SHLD)

Everywhere you look there seems to be retail chains with long histories and troubled finances. Once prosperous, these stores are attempting a turnaround in order to remain relevant in the age of the internet. As profits have fallen stock prices have followed, making investment in the stock a risky endeavor. But bond prices have also decreased, and by taking advantage of maturities only a few years away the rewards may outweigh the risks. Here are three troubled retailers which have attractive looking bonds.

J.C. Penney Company, Inc. (NYSE:JCP) – After years of slumping sales Penney began a multi-year turnaround under the leadership of new CEO Ron Johnson. The strategy involves breaking from the traditional model of handing out coupons and instead focusing on an ‘everyday low price’ model. Sales have continued to slump, with Q3 2012 seeing a year-on-year revenue decline of over 26%, although losses have narrowed.

The best looking Penney bond matures in 2017 and carries a 7.95% coupon (CUSIP: 708160BQ8). This bond is paid semi-annually and is non-callable, last trading below par at $95.50. The price has fallen considerably in the past year.

JCP Bond Price

Source: Finra

The yield to maturity, which factors in the return from both the coupon payments and the principal payment, is calculated below.

The yield to maturity of this bond is an impressive 10.84%, significantly higher than the current yield of 8.4% due to the below-par price. This bond matures in just over four years, which means that J.C. Penny’s financial situation needs to be strong enough to survive for at least that long. The balance sheet shows $525 million in cash and $2.94 billion in debt. The company paid $227 million in interest last year with a net income of $-152 million. Free cash flow was positive last year at $186 million but through three quarters of the current fiscal year has turned resoundingly negative, $-1.2 billion compared to $-600 million at the same time last year. This leads me to believe that free cash flow will be negative for the year.

Although J.C. Penny has enough cash to withstand a few years of losses, if the turnaround fails the company will very possibly go bankrupt before 2017. The default risk on this bond seems fairly high, but if you believe that the company can turn things around (like Morningstar does with its 5-star rating of the stock) then a YTM of 10.8% is highly attractive.