NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed its Issuer Default Rating (IDR) on Saks Incorporated (Saks) at 'BB'. The Rating Outlook is Stable. A full list of rating actions appears at the end of this release.
KEY RATING DRIVERS
The affirmations reflect Fitch's expectation that Saks' credit metrics will remain fairly stable over the next 12-24 months. Fitch expects adjusted debt/EBITDAR to be within 2.9x-3.1x, as debt reduction will help offset modest decline in profitability in the near term. This assumes comparable store sales (comps) growth in the 3%-4% range, which will result in expense deleveraging as Saks intensifies its capital and technology investments in 2013.
Saks' comps grew by 3.2% in 2012, following strong growth in the mid- to high-single digits in 2010 and 2011 that was driven by the overall recovery in luxury spending. The deceleration of comps in second-half 2012 was mainly due to the adverse impact of Hurricane Sandy and fiscal uncertainty. EBITDA for 2012 of $287 million (Fitch-defined EBITDA adds back stock-based compensation) was modestly lower than the 2011 level of $293 million as a result of the slowdown in top-line growth combined with investments in the merchandising systems and IT primarily to support the company's omni-channel (both physical and e-commerce) strategy.
Fitch expects comps growth for luxury department stores could decelerate to 3%-5% in 2013, after averaging 6%-8% in the past three years. Fiscal uncertainty and a slowdown in international tourist traffic could potentially dampen luxury spending. Within this context, Fitch expects Saks to generate comps growth in the 3%-4% range and SG&A expense to grow in the mid-single digits. As a result, EBITDA could drop to the $260 million level in 2013.
Given the heavy investments in its systems and IT primarily to support the company's omni-channel strategy, Saks will need to drive mid- to high-single-digit comps growth and sustain gross margin at current levels of around 41% to be able to deleverage SG&A expenses and drive operating margin improvement. Fitch does not expect significant margin improvement over the next two years unless there is significant pick-up in demand for luxury products.
Incorporated in the ratings is the lower sales productivity and profitability of Saks stores relative to its two closest peers. Saks' average sales per square foot excluding its New York flagship store which roughly constitutes 20% of overall sales (but including OFF 5TH and online sales) was approximately $380 in 2012 versus roughly $465 at Neiman Marcus full-line stores (excluding Bergdorf Goodman and online sales). As a result of lower sales productivity and higher cost structure, Saks' EBITDA margin of 9.1% as of Feb. 2, 2013 trails the 13.6% at Neiman Marcus (calendarized) and 15% at Nordstrom. Fitch does not expect Saks to close the gap with Neiman Marcus, given the latter has superior real estate locations and brand matrix within its markets.
Adjusted debt/EBITDAR remained flat at 3.1x in 2012, while EBITDAR/interest plus rents came in at 2.8x. Fitch expects leverage metrics to sustain in the 2.9x-3.1x range over the next two years, as debt reduction will help offset modest decline in profitability in the near term. The company is in the process of redeeming the $230 million of 2% convertible senior notes due 2024. Fitch expects the company will use cash on hand and tap the ABL revolver to fund the redemption and is currently assuming that all notes get redeemed rather than converted as the conversion price of the 2024 notes at $11.97 is currently above the market price. In addition, the remaining balance of $91 million in 7.5% convertible notes due December 2013 is expected to be converted into equity (given a conversion price of $5.54).
Saks' liquidity position remains strong with approximately $80 million in cash and $494 million available under its credit facility as of Feb. 2, 2013. Fitch expects Saks to generate FCF in the $60 million-$90 million range over the next two years, even as the company ramps up net capex to $140 million in 2013 from $110 million in 2012. The further step-up in capex in 2013 versus 2012 reflects increasing investments in full-line store remodeling and accelerated investments in the omni-channel strategy. Fitch expects Saks will direct free cash flow towards paying down revolver borrowings and share buybacks.
The $500 million secured bank facility is rated two notches above the IDR at 'BBB-' as the facility is secured by merchandise inventories and certain third party accounts receivables. There were no borrowings under the facility as of the end of 2012 and Fitch assumes borrowings of approximately $175 million at the end of 2013 as the company draws on the facility to fund the redemption of the 2024 notes.
The unsecured notes are currently rated 'BB'. Fitch expects to withdraw the 'BB' issue ratings after Saks completes the expected redemption or conversion of the convertible notes. Post the transactions, Saks will not have any unsecured debt on its balance sheet. Saks owns 67% of its full-line square footage, including its Fifth Avenue New York City store, which remains unencumbered.
RATING SENSITIVITIES
A positive rating action could result in the event of sustained mid-to-high single-digit growth in the top line and operating profitability improvements. For Saks to hit its leverage target of 2.5x, Fitch estimates it would need to improve EBITDA to the $325 million level.
A negative rating action could result in the event of significant pressure on same-store sales trends and reduced profitability, financial flexibility and liquidity, and adjusted leverage deteriorating to above 4x.
Fitch has affirmed the following ratings on Saks:
--Long-term IDR at 'BB';
--$500 million secured credit facility at 'BBB-';
--Senior unsecured notes at 'BB'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Evaluating Corporate Governance' (Dec. 12, 2012).
Applicable Criteria and Related Research
Corporate Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=684460
Evaluating Corporate Governance
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=694649
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