Fitch Affirms Sears Holdings at 'CC'

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has affirmed the long-term Issuer Default Ratings (IDR) on Sears Holdings Corporation (Holdings) and its various subsidiary entities (collectively, Sears) at 'CC'.

A full list of rating actions follows at the end of this release.

KEY RATING DRIVERS

EBITDA Remains Materially Negative: Fitch expects Sears' EBITDA to be in the negative $600 million range in 2015 and potentially worse in 2016. Fitch expects a revenue decline of around 20% in 2015 due to estimated domestic comparable store sales (comps) of negative 10% and ongoing store closings. Fitch expects comps to be in the negative mid-single digit range in 2016 and 2017 with top line decline potentially in the high single digit range as Sears continues to close stores.

Significant Cash Burn: Sears' interest expense, capex and pension plan contributions are expected to total $750 million-$800 million annually between 2015 and 2017. Netting this amount from Fitch's EBITDA expectation - and assuming $200 million-$300 million in net working capital benefit - leads to cash burn (CFO after capex and pension contributions) of $1 billion to $1.1 billion in 2015. Cash burn could potentially worsen in 2016, assuming EBITDA losses approach $800 million to $1 billion.

Shrinking Assets Fund Operations: Sears injected $3.1 billion in liquidity through August 2015 with $429 million from real estate joint ventures related to 31 stores with General Growth Properties, Simon Properties, and The Macerich Company (collectively 'joint venture') and $2.7 billion from the sale-leaseback transaction with Seritage Growth Properties (in which it sold 235 owned properties and its 50% interest in the joint venture). This is on top of the $6.8 billion (which includes expense and working capital reductions and debt financing activities) between 2012 and 2014 to fund ongoing operations given material declines in internally generated cash flow.

Further Asset Sales and/or Debt Funding Required Beyond 2015: Based on current EBITDA expectations, Fitch expects Sears to end 2015 with about $1.8 billion to $2 billion in liquidity. This assumes no additional asset sales above the $3.1 billion injected through August or debt issuance. As a result, Sears is likely to require an additional $1.3 billion to $1.5 billion in annual liquidity in 2016 and 2017 via further real estate transactions and/or higher borrowings, plus another $0.5 billion to fund annual seasonal working capital needs.

Below are potential sources of liquidity:

Fitch estimates that Sears still owns approximately 275 (excludes 125 of Sears full line mall stores that are in a bankruptcy remote vehicle and approximately 22 specialty stores) unencumbered Kmart discount and Sears full line mall stores. If the unencumbered real estate was valued at a similar price per square foot as the 235 properties sold under the Seritage transaction, Fitch estimates Sears could get an additional $2.6 billion in proceeds. However, the remaining portfolio could be of lower value if they are in smaller markets or declining malls and there could be restrictions on the sale of some of these properties. In addition there could be value in below market leases but the potential proceeds are difficult to estimate.

The company could also separate its Sears Auto Center business.

Finally, Sears' ability to issue incremental debt secured by receivables and inventory, which governs the borrowing base that determines the borrowing capacity on its existing credit facility (after netting out the first lien term loan and second lien secured notes, is limited given the significant reduction over the past few years in working capital.

KEY ASSUMPTIONS

--Fitch expects domestic comps of around negative 10% in 2015 and negative mid-single digit range in 2016 and 2017.

--EBITDA is expected to be approximately negative $600 million in 2015 and potentially worse in 2016 at $800 million to $1 billion.

--Fitch expects cash burn to be approximately $1 billion to $1.1 billion in 2015 based on negative EBITDA and $750 million-$800 million total in interest expense, capex, and pension expense and $200 million-$300 million in net working capital benefit.

--Total liquidity is expected to be about $1.8 billion to $2 billion at the end of 2015. Sears is likely to require an additional $1.3 billion to $1.5 billion in annual liquidity in 2016 and 2017 via further real estate transactions and/or higher borrowings, plus another $0.5 billion to fund seasonal working capital needs.

RATING SENSITIVITIES

Negative Rating Action: A negative rating action could result if Sears is unable to inject the needed liquidity to fund ongoing operations.

Positive Rating Action: A positive rating action could result from a sustained improvement in comps and EBITDA to a level where the company is covering its fixed obligations. This is not anticipated at this time.

LIQUIDITY

Sears had total cash of approximately $1.8 billion and availability under its credit facility of $1.2 billion as of Aug. 1, 2015, prior to the pay down of $936 million of second lien notes due October 2018. The borrowing availability of $1.2 billion on the undrawn $3.275 billion domestic credit facility reflected $657 million of letters of credit outstanding, the effect of the springing fixed-charge coverage ratio covenant that caps borrowing to 90% of the line cap, and another $1.1 billion that was not available due to the borrowing base limitation. Total liquidity is expected to be about $1.8 billion to $2 billion at the end of 2015.

Sears addressed the maturity of its $3.275 billion secured credit facility, which was due to mature on April 8, 2016 by extending $1.971 billion out of the total $3.275 billion to July 2020. The remainder will expire in April 2016. The company does not have any other near-term maturities.

Recovery Considerations for Issue-Specific Ratings

In accordance with Fitch's Recovery Rating (RR) methodology, Fitch has assigned RRs based on the company's 'CC' Issuer Default Rating (IDR). Fitch's recovery analysis assumes a liquidation value under a distressed scenario of approximately $6.5 billion (low seasonal inventory) to $7 billion (peak seasonal inventory) on domestic inventory, receivables, and property, plant and equipment.

The $3.275 billion domestic senior secured credit facility, under which Sears Roebuck Acceptance Corp. (SRAC) and Kmart are the borrowers, is rated 'CCC+/RR1', indicating outstanding (90%-100%) recovery prospects in a distressed scenario. Holdings provides a downstream guarantee to both SRAC and Kmart borrowings, and there are cross-guarantees between SRAC and Kmart. The facility is also guaranteed by direct and indirect wholly owned domestic subsidiaries of Holdings, which own assets that collateralize the facility.

The facility is secured primarily by domestic inventory, which is expected to range from an estimated $4.5 billion in January 2016 to about $5.5 to $5.8 billion around peak levels in the next 12 months, and pharmacy and credit card receivables, which are estimated to be $0.3 billion-$0.4 billion. The credit agreement imposes various requirements, including (but not limited to) the following provisions: if availability under the credit facility is beneath a certain threshold, the fixed-charge ratio as of the last day of any fiscal quarter should not be less than 1.0x; a cash dominion requirement if excess availability on the revolver falls below designated levels; and limitations on its ability to make restricted payments, including dividends and share repurchases.

The $983 million first lien senior secured term loan due June 2018 is also rated 'CCC+/RR1', as it is secured by a first lien on the same collateral and guaranteed by the same subsidiaries of the company that guarantee the revolving facility. Under the guarantee and collateral agreement, the revolving lenders will have priority of payment from the collateral over the $1 billion first lien term loan lenders.

The remaining $302 million second lien notes due October 2018 at Holdings, which have a second lien on the same collateral package as the credit facility and $1 billion term loan, have been upgraded to 'CCC+/RR1' from 'CCC/RR2' given the significant paydown of these notes and Fitch's expectation that Sears will not be able to issue incremental debt secured by receivables and inventory given the significant decline in borrowing base.

The notes contain provisions that require Holdings to maintain minimum collateral coverage for total debt secured by the collateral securing the notes (failing which, Holdings has to offer to buy notes sufficient to cure the deficiency at 101%) that provide downside protection. The second lien notes have an unsecured claim on the company's unencumbered real estate assets, given the notes are guaranteed by substantially all the domestic subsidiaries that guarantee the credit facility.

The senior unsecured notes at SRAC are rated 'CC/RR4', indicating average recovery prospects (31%-50%). The recovery on these notes are derived from the valuation on the company's unencumbered real estate assets held at Sears, Roebuck and Co, which provides a downstream guarantee of SRAC's senior notes and also agrees to maintain SRAC's fixed-charge coverage at a minimum of 1.1x. However, should a material portion of the owned real estate be used to raise additional liquidity, it could adversely affect the ratings on the unsecured notes. Recovery to the senior unsecured notes also takes into account potential sizable claims under operating lease obligations and the company's underfunded pension plan.

The 8% $625 million unsecured notes due 2019 at Holdings are rated 'C/RR6', given poor recovery prospects (0%-10%).

FULL LIST OF RATING ACTIONS

Fitch has affirmed the ratings as follows:

Sears Holdings Corporation (Holdings)

--Long-term IDR at 'CC';

--$302 million second-lien secured notes upgraded to 'CCC+/RR1' from 'CCC/RR2';

--$625 million unsecured notes 'C/RR6'.

Sears, Roebuck and Co. (Sears)

--Long-term IDR at 'CC'.

Sears Roebuck Acceptance Corp. (SRAC)

--Long-term IDR at 'CC';

--Short-term IDR at 'C';

--Commercial paper at 'C';

--$3.275 billion secured bank facilities ($1.304 billion due April 8, 2016 and $1.971 billion secured bank facility due July 20, 2020) at 'CCC+/RR1' (as co-borrower);

--$979 million first lien term loan at 'CCC+/RR1' (as co-borrower);

--Senior unsecured notes at 'CC/RR4'.

Kmart Holding Corporation (Kmart)

--Long-term IDR at 'CC';

Kmart Corporation (Kmart Corp)

--Long-term IDR at 'CC';

--$3.275 billion secured bank facilities ($1.304 billion due April 8, 2016 and $1.971 billion secured bank facility due July 20, 2020) at 'CCC+/RR1' (as co-borrower);

--$979 million first lien term loan at 'CCC+/RR1' (as co-borrower);

Additional information is available at '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/creditdesk/reports/report_frame.cfm?rpt_id=869362

Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 12 Jun 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=867275

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=994324

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=994324

Endorsement Policy

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

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View source version on businesswire.com: http://www.businesswire.com/news/home/20151118006386/en/

Fitch Ratings
Primary Analyst
Monica Aggarwal, CFA
Managing Director
+1-212-908-0282
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Grace Barnett
Director
+1-212-908-0718
or
Committee Chairperson
David Silverman, CFA
Senior Director
+1-212-908-0840
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
[email protected]

Source: Fitch Ratings

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