NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the Long-term Issuer Default Rating (IDR) for Dillard's, Inc. (Dillard's) at 'BBB-'. The Rating Outlook is Stable. A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS
The ratings reflect Dillard's positive comparable store sales (comps) trends and strong EBITDA growth over the past five years. Comps have increased for 14 consecutive quarters and have exceeded the industry average for most of this time frame and the company has made strong progress in improving profitability both on gross margin and expense control. With 2013 EBITDA margin of 12%, Dillard's has significantly narrowed the gap to the strong operators that have EBITDA margins in the 14%-15% range. Fitch expects Dillard's will continue to generate comps growth in the 1%-2% range over the next 24 months and EBITDA margin to remain fairly flat.
While Dillard's credit metrics are strong for the 'BBB-' rating category with adjusted debt/EBITDAR currently at 1.1x, the ratings continue to incorporate Dillard's below industry-average sales productivity (as measured by sales per square foot) and operating profitability relative to its higher rated investment-grade department store peers. Fitch expects Dillard's leverage to remain in the low-1x range over the next three years.
Dillard's is the sixth largest department store chain in the U.S. in terms of sales with retail revenue of $6.4 billion on 278 stores and 18 clearance centers in 29 states concentrated in the southeast, central and southwestern U.S. Dillard's comps have continued their positive trajectory since 2010, although growth moderated to 1.3% in 2013 versus the 3%-4% range between 2010 and 2012. The improvement has been driven by improving its merchandise assortment towards more upscale brands, better in-store execution, and strong inventory control.
The company has also taken an aggressive stance toward closing underperforming stores, closing a net 28 units or approximately 10% of its square footage since the end of 2007. However, Dillard's annual sales per square foot at approximately $125 is significantly lower than other well-operated mid-tier department store peers, which are in the $180-$200 range (based on gross square footage). This should provide further opportunity for improvement.
From a store investment perspective, capex is expected to increase to the $150 million range in 2014, versus an average of roughly $110 million over the past four years, to support increasing investments in store updates (in the higher sales generating or more productive areas of the store), online growth initiatives and some modest new store openings expected in 2014/2015. The company's real estate portfolio is in adequate shape and the improvement in comps and margin will continue to come from executing on its merchandising strategy, in Fitch's view.
Liquidity remains strong, supported by a cash balance of $237 million as of Feb. 1, 2014, and $873 million available under its $1 billion credit facility. The company has generated approximately $400 million in free cash flow (FCF; before special dividends) on average over the last four years. Fitch expects Dillard's to generate strong FCF of approximately $350 million-$400 million annually in the next two years assuming modest working capital uses and higher capex. Given no debt maturities until early 2018, Fitch expects Dillard's will direct excess cash flow toward share buybacks and/or increased dividends including any one-time special dividends.
The $1 billion senior credit facility, which is due to mature on July 1, 2018, is rated one notch above the IDR at 'BBB' as the facility is secured by 100% of the inventories at Dillard's, Inc.'s unrestricted operating subsidiaries. The $615 million of senior unsecured notes are rated at par with the IDR, while the $200 million in capital securities due 2038 are rated two notches below the IDR reflecting their structural subordination. Fitch notes that Dillard's owns 88% of its retail square footage, which is currently unencumbered.
A positive rating action could result in the event that Dillard's generates above-industry-average comparable store gains and EBITDA margins improve to the 14% - 15% range.
A negative rating action could result in the event of a return to negative sales trends and/or a more aggressive financial posture, leading to an increase in leverage ratio of more than 2.5x and/or reduced financial flexibility.
Fitch has affirmed Dillard's IDR and issue ratings as follows:
--Long-term IDR at 'BBB-';
--$1 billion secured credit facility at 'BBB';
--Senior unsecured notes at 'BBB-';
--Capital securities at 'BB'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 5, 2013);
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' (Dec. 23, 2013).
Applicable Criteria and Related Research:
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage