Fitch Affirms Sears Holdings at 'CC'

CHICAGO--(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 ratings actions follows at the end of this release.

KEY RATING DRIVERS

EBITDA Remains Materially Negative: Fitch Ratings expects Sears Holdings Corporation's comparable store sales (comps) to be in the negative mid-single digit range in 2016 and 2017, with top-line declining in the high single-digit range as Sears continues to close stores. As a result, Fitch expects 2016 EBITDA to be negative $800 million to $1 billion, compared with a loss of $836 million in 2015, even assuming targeted cost reductions of $550 million to $650 million.

Significant Cash Burn: Sears' interest expense, capex and pension plan contributions are expected to total $800 million annually in 2016 and 2017. Fitch expects cash burn (CFO after capex and pension contributions, and assuming no material swings in working capital) of $1.6 billion to $1.8 billion in 2016. Sears also needs to fund seasonal working capital needs, with inventory expected to range from $5.4 billion to $5.5 billion at the holiday peak, suggesting $500 million to $650 million is required, assuming a payables-to-inventory ratio of 30% to 35%.

Incremental Liquidity Needed in 2016: Sears has to date raised $1.55 billion through issuing a $750 million asset-backed term loan maturing July 2020, and is backed by the same collateral as its credit facility; a $500 million term loan maturing July 2017 secured by 21 properties and a $300 million term loan maturing 2020 from ESL secured by a junior lien on inventory and receivables. Fitch expects Sears to be able to fund 2016 holiday inventory through borrowings on its credit facility.

Shrinking Assets Fund Operations: Sears has injected almost

$10 billion in liquidity from 2012 to 2015 to fund ongoing operations given material declines in internally generated cash flow. This includes $4.7 billion from real estate transactions, with the remainder resulting from expense and working capital reductions and debt issuance.

Potential Sources of Liquidity: Sears still owns about 250 unencumbered Kmart discount and Sears full-line mall stores. If this was valued at a similar price per square foot as the 235 properties sold under the Seritage transaction, Sears could generate approximately $2.4 billion in proceeds. However, the remaining portfolio could be of lower value if the stores are in smaller markets or declining malls, and there could be restrictions on the sale of some of these properties based on mall operating covenants. There could also be value in below-market leases, but the potential proceeds are difficult to estimate.

Sears is also exploring strategic initiatives for its Kenmore, Craftsman and DieHard brands, and Sears Home Services businesses. However, Fitch assumes that any potential proceeds would have to be used to paydown the underfunded pension plans before they can be used to fund Sears operations, given that Sears granted Pension Benefit Guaranty Corporation (PBGC) a springing lien on these ring-fenced assets.

Restructuring Risk: Fitch believes restructuring risk for Sears remains high over the next 12 to 24 months given the significant cash burn and reduced sources of liquidity.

KEY ASSUMPTIONS

--Fitch expects domestic comps in the negative mid-single digit range in 2016 and 2017.

--EBITDA is expected to be approximately negative $800 million - $1 billion in 2016.

-- Fitch expects cash burn to be approximately $1.6 billion to $1.8 billion in 2016 based on 800 million total in interest expense, capex, and pension expense and an assumption of no material swings in working capital.

RATING SENSITIVITIES

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.

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

LIQUIDITY

Sears had total cash of $276 million and availability under its credit facility of $191 billion as of July 30, 2016. The borrowing availability of $191 million on the $1.971 billion domestic credit facility reflected $656 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 $860 million that was not available due to the borrowing base limitation.

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 $7.0 billion (peak seasonal inventory) on domestic inventory, receivables, and property, plant and equipment.

The $1.971 billion domestic senior secured credit facility, under which Sears Roebuck Acceptance Corp. (SRAC) and Kmart Holding Corporation (Kmart) are the borrowers, is rated 'CCC+/RR1', indicating outstanding (90% to 100%) recovery prospects in a distressed scenario. Holdings provide 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 $5.2 billion to $5.4 billion around holiday peak levels, and pharmacy and credit card receivables, which are estimated to be $0.3 billion to $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 $975 million first lien senior secured term loan due June 2018 and $750 million first lien secured term loan due July 2020 are also rated 'CCC+/RR1', as they are 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 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 first lien term loans, are rated 'CCC+/RR1' due to 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 the 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. Fitch also notes 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% to 50%). The recovery on these notes is 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% to 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 at 'CCC+/RR1';

--$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';

--$1.971 billion secured bank facility at 'CCC+/RR1' (as co-borrower);

--$1.7 billion first lien term loans 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';

--$1.971 billion secured bank facility at 'CCC+/RR1' (as co-borrower);

--$1.7 billion first lien term loans at 'CCC+/RR1' (as co-borrower);

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:

--Historical and projected EBITDA is adjusted for charges such as closed store charges, severance, non-cash pension expense, and gains on sale of assets. For example, Fitch added back $211 million related to these charges to its EBITDA calculation in 2015.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)

https://www.fitchratings.com/site/re/885629

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1014722

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1014722

Endorsement Policy

https://www.fitchratings.com/regulatory

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Source: Fitch Ratings

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