Fitch Affirms Kohl's IDR at 'BBB+'; Outlook Revised to Stable
KEY RATING DRIVERS
The affirmation reflects the company's strong market share position as the third-largest department store retailer in the U.S., convenient off-mall store format, strong EBITDA margin in the 13.8%-14% range and strong free cash flow generation. The revision to a Stable Outlook reflects Fitch's expectation that Kohl's operating performance will stabilize in 2015, and for leverage to be in the 2.3x range over the next two to three years. Fitch expects Kohl's top-line growth to be in the positive 1.5%-2.0% range, which reflects flat to modestly negative store level comparable store sales (comps) growth, versus negative 2% in 2014, and online sales growth in the mid-teens that would contribute roughly 150 bps to overall comps.
While store traffic trends remain weak given the company's budget-constrained and value-focused customer base, Kohl's has taken various initiatives to improve sales, including investments in its omnichannel platform and increasing national brand presence to compete more effectively against the growth in off-price retailers. Comp for 2014 were down 0.3%, with total sales growth flat for the year. The close to flat comp was mainly due to a stronger than expected fourth quarter comp of positive 3.7%. Online revenue has been a major contributor to top line, growing from approximately \$740 million in 2010 to over \$2 billion in 2014, contributing over 150 bps to overall comps annually, essentially offsetting negative store level comps. Fitch expects store level comps to be flat to modestly negative over the next 24-36 months, which along with mid-teens growth in ecommerce, should generate top line growth of 1.5% to 2.0% annually.
Kohl's continued to focus on upgrading its national brand presence, adding over 15 new brands to its portfolio in 2014, realizing 180 bps growth in national brand penetration to 50% of sales. These include IZOD, Juicy, Fitbit, and Nespresso, as well as its recent partnership with Bliss. The national brands contributed to a higher AUR (average unit retail) and the company expects penetration to continue to increase. Given more emphasis on national brands, Fitch believe Kohl's is better positioning itself to be more competitive in the market against off-price retailers that offer well recognized brands at highly competitive or discounted prices.
Fitch expects Kohl's gross margin to be relatively flat in the mid-36% range over the next 24 months. Kohl's EBITDA margin is expected to be stabilize around 14% in 2015. This is relative to the 15.8%-15.9% range in 2010/2011, given weakness in comps and Kohl's investments in sharper pricing, inventory repositioning, and omnichannel initiatives. However, the current EBITDA level is still in-line with other industry leaders in the department store space such as Macy's Inc. and Nordstrom, Inc.
Fitch expects Kohl's annual EBITDA to hover around the \$2.6 billion - \$2.7 billion level over the next 24 months and adjusted debt/EBITDAR to be in the 2.3x range over the next two to three years, modestly above the company's currently stated leverage target of 2.0x-2.25x.
Kohl's liquidity is supported by its strong cash balance of around \$1.4 billion as of Jan. 31, 2015, and a \$1 billion senior unsecured revolving bank credit facility due in June 2018. Kohl's has no debt maturities prior to 2017. Kohl's has generated strong FCF of \$950 million to \$1 billion annually since 2010 (with the exception of 2012 when FCF was \$180 million given a working capital use of \$0.5 billion and elevated capital expenditure). Fitch expects FCF to be in the \$700 million range annually over the next 24 -36 months. This assumes working capital swings are neutral and a ramp up capital expenditures to the \$800 million range to support e-commerce growth, store openings (handful of units 2015), remodelling program (12 expected in 2015, 50 in 2016, and 75 in 2017), and expansion of its beauty presence. Kohl's provided the breakdown for capex as follows: \$350 million for IT spending, \$250 million for store strategies including new stores, remodel, beauty and other Easy Experience initiatives, and \$200 million for base capital projects. Fitch expects FCF to be directed toward share buybacks.
--Fitch's expects overall top-line growth to be in the positive 1.5%-2.0% range, which reflects flat-to modestly negative store level comps growth and online sales growth in the mid-teens that would contribute roughly 150 bps to overall comps.
--Kohl's annual EBITDA is expected to stabilize in the \$2.6 billion - \$2.7 billion range and adjusted debt/EBITDAR to be in the 2.3x range over the next two to three years, modestly above the company's currently stated leverage target of 2.0x-2.25x.
--Fitch expects FCF to be in the \$700 million range annually over the next 24 -36 months, a decline from the \$950 million to \$1 billion level, reflecting a ramp up in capital expenditures to the \$800 million range and assuming working capital swings are neutral.
A positive rating action is unlikely at this time as Fitch anticipates Kohl's will manage its capital structure to its publicly stated target 2.0x-2.25x consolidated debt/EBITDAR leverage using 8.0x net rent expense.
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 1.5% or better in the next 12-24 months.
--A weakening profitability profile (where EBITDA drops to below \$2.6 billion) and/or a more aggressive financial posture that would take leverage above 2.5x.
Fitch has affirmed Kohl's ratings as follows:
--Long-term IDR at 'BBB+';
--\$1 billion bank credit facility at 'BBB+;
--Senior unsecured notes and debentures at 'BBB+'.
The Rating Outlook has been revised to Stable from Negative.