TEXT - Fitch affirms Kohl's 'BBB+' issuer default rating
Feb 13 - Fitch Ratings has affirmed its ratings on Kohl's Corporation's (Kohl's) Issuer Default Rating (IDR), $1 billion revolver and $2.5 billion of senior notes and debentures at 'BBB+'. The Rating Outlook is Stable. A full list of rating actions appears at the end of this press release. KEY RATING DRIVERS The ratings reflect Kohl's stable market position as the third-largest department store retailer in the U.S., industry-leading operating margins, convenient off-mall store format, and strong growth in higher-margined private and exclusive brands. Concerns include the softness in comparable store sales trends (comps) that have been weak since the fourth quarter of 2011 (4Q'11). The inability to stabilize store-level comps (excluding the positive impact from e-commerce sales) over the next 12-18 months could lead to ratings pressure. Kohl's has added about $13 billion in sales and grown its market share to over 10% since 2000 in a sector that has shrunk about 20%, through a strong organic growth program and above-industry average comps through 2010. While Kohl's market share has been stable for the past two years, the company has reported weaker-than-expected comps over the past five quarters (with comps including online sales at +0.5% and +0.3% in 2011 and 2012, respectively) as the company's inflation-driven price increases in late 2011 and inventory short-stocking particularly at the opening price points hampered traffic given its highly price-sensitive and budget-constrained customer base. Fitch calculates that comps at the retail stores declined by 0.9% and 1.8% in 2011 and 2012, respectively. The weakness in retail store comps has been offset by the strong growth in online sales, which contributed approximately 1.5% to comps in 2011 and 2% in 2012. At the current rating level, Fitch would expect Kohl's to continue to gain market share which would require the company to generate comps in the 1%-1.5% range. This would require stabilization in store-level comps, assuming 15%-20% growth in online sales. Fitch expects Kohl's comps to improve through 2013 as the company continues to invest in sharper pricing and adjust for the right inventory content and level to regain traffic. Overall sales are expected to grow in the 1.5% to 2% range in 2013/2014 as Kohl's square footage growth has slowed down significantly since 2008 and is expected to remain in the low single digit range in the next two to three years. This assumes 12 store openings in 2013 compared with 21 in 2012 and 40 in 2011, mostly in its small-box format. Kohl's EBITDA margin is expected to be 14.5% in 2012 versus 15.9% in 2011 given the significant decline in gross margin (given investment in sharper prices and weaker than expected comps). Gross margin could remain under pressure through first-half 2013 as the company continues to have to invest in lower prices and inventory repositioning. However, Fitch expects Kohl's EBITDA margin to stabilize at around 14%, which would still be strong for the sector and in line with Macy's. Kohl's industry-leading operating margins have been historically supported by its strong price image in the moderate department store space, growth in higher margined private and exclusive brands, and well managed inventory. This has provided the company some flexibility to invest in sharper pricing over the last four to five quarters. Adjusted debt/EBITDAR at the end of 2012 is expected to increase to 2.2x versus 2.0x in 2011 on EBITDA decline of nearly 7% and higher debt balances. Fitch expects leverage ratios could remain in the 2.3x-2.4x range over the next two to three years, which is modestly above the company's currently stated leverage target of 2.0x-2.25x, but consistent with the 'BBB+' rating level. Fitch expects working capital to be a cash drain (partly due to high inventory levels and a shift in payables due to the 53rd week) and hurt free cash flow (FCF) generation in 2012. FCF is expected to be approximately $700 million in 2013-2014. This assumes working capital is neutral and capital expenditures are in the $800 million range to support e-commerce growth and its store opening and remodelling program (30 expected for 2013 versus 50 in 2012 and 100 in 2011). Fitch expects FCF to be directed toward share buybacks. Kohl's liquidity is supported by its strong cash balance and a $1 billion senior unsecured revolving bank credit facility due in June 2016. Kohl's has no debt maturities prior to 2017 and Fitch expects the company will continue to be disciplined in managing its cash flow allocation, share repurchases, and debt levels. RATING SENSITIVITIES A negative rating action could result in the event of one or more of the following: --If retail store comps fail to stabilize and overall comps (including online sales) do not improve to a level of 1% or better. --A weakening profitability profile (where EBITDA drops to below $2.5 billion from an expected $2.8 billion in 2012) and/or a more aggressive financial posture that would take leverage above 2.5x. A positive rating action is unlikely at this time as it would require Kohl's to manage adjusted leverage to below its stated target of 2.0x-2.25x. Fitch has affirmed the followings: --Long-term Issuer Default Rating (IDR) at 'BBB+'; --$1 billion bank credit facility at 'BBB+; --$2.5 billion senior unsecured notes and debentures at 'BBB+'. The Rating Outlook is Stable.