-- We expect profitability at U.S. specialty department store Kohl's
Corp. to narrow in the remainder of fiscal year ending Feb 2, 2013,
given weak sales trends and lead to a modest deterioration of credit protection
-- We are affirming all ratings on Kohl's, including the 'BBB+' but
revising the outlook to negative from stable.
-- The negative outlook on Kohl's reflects our expectation that weak
sales trends could persist into 2013 due to merchandising issues and
competitive pressures, resulting in a further constraint on its credit
On Dec. 12, 2012, Standard & Poor's Ratings Services revised its outlook on
Kohl's Corp. to negative from stable. We affirmed all ratings on the company,
including the 'BBB+' corporate credit rating.
The outlook revision is based on our expectation that weak sales could
continue into 2013 and result in a further deterioration of the company's
The ratings on Menomonee Falls, Wis.-based Kohl's Corp. reflect our assessment
of a "satisfactory" business risk profile and an "intermediate" financial
We expect Kohl's to maintain a satisfactory business profile supported by a
solid market position as a family-oriented specialty department store, good
execution of a value-focused merchandising strategy, solid measures of
profitability, and geographic diversity.
Kohl's sales trends have weakened in recent quarters and lagged its peers.
Comparable store sales declined 1.1% year to date as of Nov. 29, 2012. We
believe competitive pressure and merchandising issues have contributed to the
sales weakness and now expect sales trends to remain soft for the remainder of
this year. We also expect margins to contract significantly due to price
investments to increase value offerings as well as promotions to drive sales.
Kohl's has achieved strong growth of online sales, but this segment has a
lower gross profit margin (29%) than its stores (38%). Still, we expect Kohl's
operating performance to remain adequate. Kohl's operating metrics, which
include EBITDA margins and sales per square foot, still compare favorably with
its peers due to its higher mix of private-label and exclusive brand
penetration and its low-cost store development strategy. Still, Kohl's
participates in the highly competitive midtier department store sector, which
remains under pressure because of the weak U.S. economy and cautious consumer
spending. Kohl's focus on maintaining a low-cost structure similar to that of
discount stores, keeping real estate and construction costs low, and using
relatively inexpensive store decor and fixtures are central to its moderate
pricing strategy and overall good profitability.
Our revised assumptions for fiscal 2012 are:
-- Sales growth of 1.9% as store growth and robust online sales growth
offsets a 2% decline in sales per square foot;
-- Gross margin declining 120 basis points (bps) due to price investments
and increased promotional activity to drive sales;
-- EBITDA margin contracting 140 bps due to some sales deleveraging and
declining gross margins;
-- We expect free cash flow to remain solid at over $800 million as
Kohl's reduces capital spending to about $800 million; and
-- Debt leverage to increase to about 2.4x as EBITDA declines by about 7%.
We also believe Kohl's will maintain a moderate financial policy commensurate
with the investment-grade rating. We view Kohl's financial risk profile as
intermediate. For 2012, we expect total debt to EBITDA to reach 2.4x compared
with 2.1x in 2011; EBITDA interest coverage to decline to the mid-5x area
compared with 6.0x and we project funds from operations (FFO) to debt to
narrow to 27% from 33%. In light of softening sales and margins, Kohl's plans
to scale back store openings and remodels to about 12 new stores and 30
remodels in 2013. We expect the company to fund share repurchases and dividend
payments with excess cash flow, thereby maintaining credit ratios in line with
an intermediate financial risk profile.
We believe Kohl's liquidity is "strong," indicating that cash sources should
exceed cash needs over the next 12 to 24 months. Our view of the company's
liquidity profile incorporates the following expectations:
-- Sources to cover uses by more than 1.5x;
-- We expect net sources of cash would be positive, even with a 30% drop
-- Kohl's has well-established and solid relationships with banks, and
has a generally high standing in the credit markets;
-- Kohl's likely can absorb low-probability shocks, based on positive
cash flow and current cash balances; and
-- Manageable debt maturities over the intermediate term.
Cash sources include about $550 million of cash on hand as of Oct. 27, 2012,
free operating cash flow (FOCF) of over $800 million in 2012, and
approximately $1 billion available under its credit facility.
Cash uses include about $800 million of capital expenditures for 2012. The
company recently increased its share repurchase program by $3.2 billion to
$3.5 billion and expects to complete this program in the next three years. We
expect the company to use its free cash flow to fund share repurchases and
The negative outlook on Kohl's reflects our expectation that weak sales trends
could persist into 2013 due to merchandising issues and competitive pressures,
resulting in a further deterioration of its credit protection measures.
We could lower the rating if Kohl's sales and profitability underperform our
expectations, such that EBITDA falls 15%, causing leverage to approach 2.6x.
This could occur if sales decline 1% and gross margin narrows 170 bps. We
could also consider a downgrade if Kohl's leverage rises to the 2.6x as a
result of increased share repurchase activity.
We will consider an outlook revision to stable if Kohl's can restore sales and
profit growth while lowering debt leverage to the low-2.0x area on a sustained
basis. For this to occur, EBITDA would need to increase about 5% from fiscal
2011 levels on a 4% revenue growth, while gross margin remains flat.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Use Of CreditWatch And Outlooks, Sept. 14, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
Temporary contact numbers: Ana Lai (917-584-4772); David Kuntz (646-596-1505)
Ratings Affirmed; Outlook Action
Corporate Credit Rating BBB+/Negative/-- BBB+/Stable/--
Senior Unsecured BBB+ BBB+