Fitch Affirms Dillard's IDR at 'BBB-'; Outlook Stable

NEW YORK--()--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

Dillard's is the sixth largest department store chain in the U.S. in terms of sales, with LTM retail revenue of $6.3 billion and 272 stores and 22 clearance centers in 29 states concentrated in the southeast, central and southwestern U.S. Dillard's generated positive comp growth between 2010-2014 by improving its merchandise assortment towards more upscale brands, better in-store execution, and strong inventory control.

More recently, operational challenges in the mid-tier department store sector and exposure to oil-dependent states of Texas, Louisiana, and Oklahoma (28% of stores) have caused the company's comps to decline meaningfully from positive 1% in 2014 to negative 2% in 2015 and negative 5% in first half 2016. Mid-market apparel sales have been weak due to a number of factors, including lack of compelling fashion trends and share loss to lower-priced competitors such as fast-fashion and off-price players. In-store apparel sales have been further pressured by share migration online. Fitch expects the general malaise in apparel sales, particularly in the mid-tier space, to persist throughout 2016.

Fitch expects Dillard's comparable store sales (comps) to be negative 3%-4% in 2016, assuming comps in the second half moderate to the negative low-single digit range, and flat to modestly negative in 2017. Fitch's EBITDA projection of approximately $600 million is 30% lower than the $800 million level generated annually between 2012-2014. Fitch expects EBITDA will be in the $550 million range in 2017 and 2018 given our comp expectations. From a margin perspective, this would reflect an EBITDA margin of 9% in 2016 compared to around 12% between 2012 and 2014.

While Dillard's credit metrics remain strong for the 'BBB-' rating category with adjusted debt/EBITDAR expected to remain in the 1.5-2x range over the next three years, the ratings continue to incorporate Dillard's below industry-average sales productivity (as measured by sales per square foot) and operating profitability and geographical concentration relative to its higher rated department store peers. Fitch expects Dillard's market share to of the overall apparel and accessories category to decline modestly in the near to intermediate term as long-term secular trends in the department store space remain negative and the decline in mall traffic has accelerated.

The company continues to focus on closing underperforming stores, closing a net 32 units or approximately 10% of its square footage since the end of 2007. From a store investment perspective, annual capex is expected to moderate to approximately $120 million from a level of about $160 million during the past two years. The company continues to support increasing investments in store updates (in the higher sales-generating or more productive areas of the store) and online growth initiatives.

The $1 billion senior unsecured credit facility, which matures in May 2020 and the $615 million of senior unsecured notes are rated at par with the IDR at 'BBB-', while the $200 million in capital securities due 2038 are rated two notches below the IDR reflecting their structural subordination. Dillard's owns 89% of its retail square footage, all of which is unencumbered.

KEY ASSUMPTIONS

--Comps decline of 3%-4% in 2016, assuming comps in the second half moderate to the negative low-single digit range, and be flat to modestly negative thereafter;

--EBITDA expected to decline to $600 million in 2016 and trend toward $550 million thereafter;

--EBITDA margin expected to decline to around 9% versus the 12% range in 2012-2014 and remain flat thereafter;

--Adjusted debt/EBITDAR to be in the 1.5x-2.0x range over the next 24-36 months;

--FCF of approximately $250 million annually, which Fitch expects will be directed toward share buybacks and/or increased dividends including any one-time special dividends.

RATING SENSITIVITIES

A positive rating action could result in the event that Dillard's generates above-industry-average comparable store gains and EBITDA margin improves to the 12% - 13% range.

A negative rating action could result if sales remain materially negative leading to higher than expected EBITDA declines and/or a more aggressive financial posture, leads to an increase in leverage ratio of more than 2.5x with reduced financial flexibility.

LIQUIDITY

Liquidity remains strong, supported by a cash balance of $128 million as of July 30, 2016, and $974 million available under its $1 billion credit facility, net of letters of credit outstanding. The company generated approximately $270 million in free cash flow (FCF) in 2015, lower than the $450 million generated in 2014 due to lower EBITDA and a working capital drain. Annual FCF is expected to be around $250 million annually going forward even at a reduced EBITDA range of $550 million - $600 million, assuming modest working capital uses and capex around the $120 million level. Fitch expects Dillard's will direct excess cash flow toward share buybacks and/or increased dividends including any one-time special dividends and refinance upcoming maturities of $250 million in 2018.

FULL LIST OF RATING ACTIONS

Fitch has affirmed Dillard's ratings as follows:

--Long-term IDR at 'BBB-';

--$1 billion unsecured credit facility at 'BBB-';

--Senior unsecured notes at 'BBB-';

--Capital securities at 'BB'.

The Rating Outlook is Stable.

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:

--Fitch has adjusted the historical and projected debt by adding 8x yearly operating lease expense.

Additional information is available on www.fitchratings.com

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/site/re/869362

Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis (pub. 29 Feb 2016)

https://www.fitchratings.com/site/re/878264

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1011169

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1011169

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Monica Aggarwal, CFA, +1-212-908-0282
Managing Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
David Silverman, CFA, +1-212-908-0840
Senior Director
or
Committee Chairperson
Jack Kranefuss, +1-212-908-0791
Senior Director
or
Media Relations
Alyssa Castelli, New York, +1-212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Monica Aggarwal, CFA, +1-212-908-0282
Managing Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
David Silverman, CFA, +1-212-908-0840
Senior Director
or
Committee Chairperson
Jack Kranefuss, +1-212-908-0791
Senior Director
or
Media Relations
Alyssa Castelli, New York, +1-212-908-0540
alyssa.castelli@fitchratings.com