S&P Lowers Outlook on Kohl's Corp. (KSS) to Negative; Notes 'Continued Soft Performance'

August 12, 2016 11:38 AM EDT

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S&P Global Ratings revised its outlook on the Kohl's Corp. (NYSE: KSS) to negative from stable. At the same time, we affirmed all ratings, including the 'BBB' corporate credit rating.

"The outlook revision reflects the company's continued soft operating performance, and our expectation that these trends will likely persist over the next 12 to 24 months, despite the sales decline moderation and some margin recovery in the fiscal second quarter ended July 30," said credit analyst Helena Song. "We expect leverage to remain in the mid- to high-2x and the outlook revision also incorporates that operating performance and leverage could be worse than our base-case scenario."

The negative rating outlook indicates a one-in-three chance we could lower the ratings in the next 12 to 24 months. We believe the apparel retail market will remain weak and that operating performance will continue to be pressured for Kohl's, leading to weakened credit metrics, including adjusted leverage in the mid- to high-2x range.

We could lower the ratings if Kohl's sales and profitability underperform our base-case expectations, resulting in further deterioration in credit metrics, including adjusted leverage increasing to about 3x and above on a sustained basis. This could happen because of heightened industry competition and continued declines in customer traffic, such that EBITDA declines by 10% or more and debt leverage increases to 3.0x. For example, we estimate this could occur if comparable sales decline 4% or greater and gross margin contract an additional 100 basis points (bps) versus our base case projections. A downgrade could also occur if weakened industry trends and operating metrics results in us viewing Kohl's competitive standing less favorably. Although less likely, we could also lower the ratings as a result of higher-than-expected share repurchase activity funded with incremental debt such that leverage increases more than 3x.

Although not likely in the next year, we could revise the outlook to stable if the customer traffic and the company's operating performance improves, with margin improvement and top-line growth resulting in sustained debt leverage in the low- to mid-2x area. This could happen if the company generates modest comparable sales growth and margins expand by 100 bps while debt remains generally consistent. This could occur is EBITDA increases about 10% or more from our forecast.

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