January 6, 2017 / 5:21 PM / 2 years ago

Fitch Affirms Kohl's Corporation at 'BBB'; Outlook Revised to Negative

(The following statement was released by the rating agency) NEW YORK, January 06 (Fitch) Fitch Ratings has affirmed the Long-Term Issuer Default Rating (IDR) for Kohl's Corporation (Kohl's) at 'BBB'. The Rating Outlook has been revised to Negative from Stable. A full list of ratings is provided at the end of this release. The Negative Outlook reflects Fitch's reduced confidence in Kohl's ability to stabilize comparable store sales and therefore EBITDA over the next 24-36 months. EBITDA is expected to be $2.3 billion in 2016, down 10% from 2015 levels of $2.5 billion and adjusted leverage is expected to be 2.7x. A ratings downgrade could result if EBITDA is sustained below $2 billion which would result in leverage of low 3x, assuming flat debt levels. The Rating Outlook could be stabilized if EBITDA remains around current levels on modestly positive comps and some gross margin improvement on further inventory reductions. KEY RATING DRIVERS CONTINUED MID-MARKET APPAREL WEAKNESS The 2016 fall/holiday period reflects continued disappointment on both top line and gross margin among the traditional mid-market department store sector. Competition from the off-price, fast-fashion and online channels has proven to be unrelenting, with the retailers' own online growth unable to mitigate accelerating in-store traffic declines. The acceleration of store closings and restructuring activity from cash-constrained specialty apparel players and department stores is likely to reshape the U.S. mall space over the next three to five years, including mall repositionings and full-scale mall closures. This could continue to adversely impact and potentially accelerate the decline in in-store traffic over the next few years. In addition, spending focus on services and experiences appears here to stay, so the dividing line between best-in-class retailers and market share donors is increasingly going to be determined by which retailers can cater to the evolving landscape. Successful retailers have to continue to ramp up investments in the omni-channel model, rightsize their store footprint and have a differentiated product and service offering to draw customers in. Compared to other department store chains, Kohl's has traditionally benefited from its off-mall real estate base and its value-oriented positioning. However, its exclusive and private brand offering -- which offered differentiated product at attractive price points and were a hallmark of Kohl's success between 2000-2010 -- has become less compelling in the face of heavily discounted branded product readily available in the off-price channel and lower priced product at fast fashion retailers. The company's ability to effect the appropriate strategic actions to stem traffic erosion over the next several years has become more uncertain. Fitch believes Kohl's will need to continue investing significantly in omni-channel capabilities, store remodels, and national brand presence to stabilize sales and compete more effectively against the growth in off-price retailers. Recent wins such as Under Armour are a positive which combined with continued growth in online sales should provide comp uplift in the 250 basis points (bps) range in 2017. However, this will likely not to be enough to offset 3%+ decline at the store level. EBITDA COULD DECLINE TO $2 BILLION BY 2018 Kohl's comparable store sales (comps) have essentially been flat between 2011-2015, with online growth estimated to contribute an average of 2% to comps annually. Fitch estimates that in-store level comps were in the negative 2.5%-3% range between 2013-2015 but have worsened to negative 4.5%-5% in 2016. As a result, overall comps are expected to be decline 2.0%-2.5% in 2016 and remain modestly negative over the next 24-36 months. EBITDA is expected to maintain the negative growth track it began following its peak $3 billion level in 2011, due to the significant deceleration in store level comps, increased online penetration, promotional activity to clear excess merchandise, increased omnichannel investments and expense deleverage. Gross margin is expected to decline 10 bps to 15 bps annually given the migration of sales online, relative to Kohl's projection flat to up 20 bps per year which it expects to achieve through better inventory management, localization and its speed initiatives. Fitch expects SG&A to grow 1%-2% annually, barring a significant cost restructuring program which is not anticipated at this time. EBITDA could therefore trend to $2 billion by 2018, versus a projected $2.3 billion in 2016. LEVERAGE TO REMAIN ELEVATED Kohl's adjusted leverage has moved from the low-2.0x range in 2012 to 2.7x primarily on EBITDA declines. Kohl's continues to generate strong free cash flow after dividends (FCF) which is expected to be $700 million to $800 million in 2016, reflecting a significant reduction in working capital, and $300 million in 2017. However, FCF is expected to be used for share repurchases rather than debt paydown. As a result, adjusted leverage is expected to remain in the high-2.0x range. KEY ASSUMPTIONS --Fitch expects overall top-line growth to be down modestly over the next two years, driven by low-double digit e-commerce growth and negative 3% decline in store-level comps. --Annual EBITDA is expected to decline from $2.3 billion in 2016 to the $2.0 billion by 2018 on modest gross margin contraction, continued SG&A investments and fixed-cost pressures. --FCF after dividends of $800 million to $900 million in 2016 (due to positive working capital contribution of $350 million to $450 million). Fitch expects FCF to be $300 million in 2017, assuming $800 million in capex and absent working capital improvement although the company expects further benefits. Fitch expects FCF to be used towards share buybacks. --As a result of negative EBITDA growth and flattish debt levels, adjusted debt/EBITDAR is expected to trend toward 3.0x by the end of 2018. RATING SENSITIVITIES A negative rating action could result if EBITDA margin declined below 11% on low-single digit sales declines, resulting in EBITDA below $2.0 billion and adjusted leverage above 3.0x. The Ratings Outlook could be stabilized if EBITDA remains around current levels on modestly positive comps and some gross margin improvement on further inventory reductions. A positive rating action to 'BBB+' would occur if a reacceleration of comps drove EBITDA above $2.6 billion, yielding adjusted leverage in the low-2.0x. This is not expected at this time. LIQUIDITY Kohl's liquidity is supported by its strong cash balance of $597 million as of Oct. 29, 2016, and a $1 billion senior unsecured revolving bank credit facility due in July 2020. Kohl's has no debt maturities prior to 2021. Fitch expects FCF after dividends of $700 million to $800 million in 2016 (due to positive working capital contribution of $250 million to $350 million) and $300 million in 2017. Fitch expects FCF to be used towards share buybacks as the company has not expressed any intention to pay down debt at this time. FULL LIST OF RATING ACTIONS Fitch has affirmed the following ratings: Kohl's Corporation --Long-Term IDR at 'BBB'; --$1 billion bank credit facility at 'BBB'; --Senior unsecured notes and debentures at 'BBB'. The Rating Outlook is revised to Negative from Stable. Contact: Primary Analyst Monica Aggarwal, CFA Managing Director +1-212-908-0282 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst David Silverman, CFA Senior Director +1-212-908-0840 Committee Chairperson Carla Norfleet Taylor, CFA Senior Director +1-312-368-3195 Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: alyssa.castelli@fitchratings.com. Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below: --Historical and projected EBITDA is adjusted to add back non-cash stock based compensation and exclude restructuring charges. For example, Fitch added back $48 million in noncash stock based compensation to its EBITDA calculation and excluded $169 million loss on extinguishment of debt in 2015. --Fitch has adjusted the historical and projected debt by adding 8x annual gross rent expense. Additional information is available on www.fitchratings.com. Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here _id=1017281 Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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