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Fitch Affirms Macy's, Inc. at 'BBB'; Outlook Revised to Negative
January 6, 2017 / 5:18 PM / a year ago

Fitch Affirms Macy's, Inc. 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) on Macy's, Inc. (Macy's) and Macy's Retail Holdings, Inc. (MRHI) at 'BBB' and affirmed the short-term IDR at 'F2'. The Rating Outlook has been revised to Negative from Stable. A full list of rating actions follows at the end of this release. The Negative Outlook reflects Fitch's reduced confidence in Macy's ability to stabilize comparable store sales and therefore grow EBITDA over the next 24 to 36 months. EBITDA is expected to be $2.7 billion to $2.8 billion in 2016 (excluding real estate gains), down 15% from 2015 levels of $3.2 billion and adjusted leverage is expected to be 3.1x. A ratings downgrade could result if leverage remains elevated in the low 3x range. The Rating Outlook could stabilize if EBITDA remains at current levels or improves modestly to $3 billion and Macy's commits to debt paydown and significantly reduces share buybacks such that leverage improves to the mid-2x range. 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. Longer-term, Fitch still views Macy's as well positioned to accelerate share gains in the mid-tier department store space as it continues to benefit from its My Macy's localization initiatives and invests in its omni-channel and other growth initiatives. The company is proactively rationalizing its store footprint and aggressively reducing its cost structure, using the expense savings and proceeds from real estate monetization to invest in its digital business, store-related growth strategies, Bluemercury, Macy's Backstage and China. The company also benefits from relationships with key national brand vendors, especially given more acute challenges elsewhere in the department store sector. Macy's recently announced a series of actions to streamline its store portfolio and intensify cost efficiency efforts which is expected to generate annual expense savings of approximately $550 million, beginning in 2017, enabling the company to invest an additional $250 million while providing incremental EBITDA protection. These savings, combined with savings from initiatives implemented in early 2016, are expected to deliver in excess of $500 million in net expense reduction. Rationalization and Monetization of Real Estate The company continues to pursue the creation of shareholder value through real estate initiatives using a three pronged strategy of closing underperforming stores, managing its flagship assets and creating value from the remaining real estate portfolio. The company announced approximately 100 store closures in August 2016, of which 68 are expected to close by mid-2017 (Three closed mid-2016, 63 will be closed in early spring 2017 and two will be closed in mid-2017 on a base of 730 Macy's stores). These store closures are expected to negatively impact 2017 sales by approximately $575 million, or around 2% of expected 2016 revenue, net of projected retained sales. The remaining 30 stores will be closed over the next few years at lease expirations or via sale transactions. In total, Fitch estimates that the company would have reduced its Macy's full line square footage by almost 15% since 2011. Macy's believes there is potential for value creation from partnership or joint venture opportunities for its flagship properties (Herald Square, Union Square in San Francisco and State Street in Chicago) where square footage could be partially repurposed, such as the partnership with Tishman Speyer on its downtown Brooklyn store to redevelop part of an existing New York-based store into office space. In addition, the company has signed an agreement to sell the downtown Minneapolis store to the 601W Companies, whose intention is to redevelop the building into creative office space on the upper floors and to pursue retail opportunities on the street and skywalk levels. These transactions could be for individual properties or could extend to its mall-based stores and be significantly more broad-based than these four properties. Macy's entered into an agreement with Brookfield Asset Management that provides Brookfield the exclusive right for up to 24 months to create 'pre-development plans' for each of the approximately 50 Macy's properties (primarily owned and ground-leased stores) that are part of the agreement. The company has also been monetizing less productive stores in weak malls, evidenced by the sale of five stores to General Growth Properties in October 2016 for $46 million. EBITDA DECLINES OVER 30% SINCE 2014 PEAK While all the steps outlined above are a step in the right direction, they may not be adequate in the near term to offset the instore traffic erosion and stabilize EBITDA. Macy's comparable store sales (including licensed departments) trends decelerated over the course of 2015 from negative 0.1% in the first quarter (1Q) to negative 4.3% in 4Q, finishing 2015 at negative 2.5%. Macy's comps are expected to be negative 3% in 2016 and approximately negative 2% in 2017. Fitch estimates Macy's ecommerce sales as 15% of total revenue (or $4 billion) in 2015; assuming this grew in the mid-teens and contributed over 200 bps to overall comps, in-store levels sales declined in the mid-single digits in 2016. In-store comp declines would have to be in the low single digits for overall comps to stabilize. Fitch projects 2016 EBITDA $2.7 billion to $2.8 billion (excluding real estate gains), a decline of over 30% since 2014 peak EBITDA level of $4 billion. EBITDA could trend below $2.5 billion over the next 24 months if comps remain in the negative low single digits assuming flattish gross margins and some expense reduction. As a result, adjusted leverage could remain elevated in the low 3x range barring significant debt paydown. KEY ASSUMPTIONS --Fitch expects low single digit comp store decline over the next two years, driven by low-double digit e-commerce growth and negative 3%-4% decline in store-level comps. --EBITDA declines approximately 5% to about $2.5 billion in 2017 from a projected $2.7 billion to $2.8 billion in 2016. This assumes flattish gross margins and 2% reduction in SG&A dollars in 2017. --FCF after dividends is expected to be approximately $500 million in 2016 and $400 million in 2017, assuming capex of $900 million annually. Macy's would need to see an improvement in EBITDA from current levels or significant debt reduction (>$1 billion) to yield adjusted debt/EBITDAR below 3x. RATING SENSITIVITIES A ratings downgrade could result if leverage remains elevated in the low 3x range. The Ratings Outlook could be stabilized if EBITDA improves modestly to $3 billion and Macy's commits to debt paydown and significantly reduces share buybacks such that leverage improves to the mid-2x range. A positive rating action could result if comps turn positive and share gains are sustained, while having and maintaining a public commitment to operate with an adjusted leverage in the low 2.0x range. This is not anticipated at this time given Macy's publicly stated target of maintaining leverage in the 2.5x to 2.8x range (using the company's calculation methodology which translates into 2.4x-2.7x on Fitch's calculation that capitalizes rent at 8x). LIQUIDITY Liquidity was supported by a cash balance of $457 million as of Oct. 29, 2016. In addition, Macy's had full availability under its $1.5 billion credit facility due May 2021. Macy's had $52 million in commercial paper outstanding at the end of 3Q16 to fund seasonal working capital. Fitch expects cash on balance sheet at the end of 2016 to be flat to higher than the $1.1 billion in 2015 given FCF generation and proceeds from asset disposals, offset by its debt maturing paydown and share buybacks. FCF after dividends is expected to be approximately $500 million in 2016 and $400 million in 2017, assuming capex of $900 million annually. FULL LIST OF RATING ACTIONS Fitch has affirmed the following ratings: Macy's, Inc. (Macy's) --Long-term IDR at 'BBB'; Macy's Retail Holdings, Inc. (MRHI): --Long-term IDR at 'BBB'; --$1.5 billion bank credit facility at 'BBB'; --Senior unsecured notes and debenture at 'BBB'; --Short term IDR at 'F2'; --Commercial paper at 'F2'. The Rating Outlook has been 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: Additional information is available on 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 gains related to asset sales. For example, Fitch excluded $212 million in asset sale gains and added back $65 million in noncash stock based compensation to its EBITDA calculation in 2015. --Fitch has adjusted the historical and projected debt by adding 8x yearly operating lease expense. Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here _id=1017280 Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. 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