OREANDA-NEWS. Fitch Ratings has upgraded the Long-term Issuer Default Rating (IDR) on Macy's, Inc. (Macy's) and Macy's Retail Holdings, Inc. (MRHI) to 'BBB+' from 'BBB' and affirmed the short-term IDR at 'F2'. The Rating Outlook is Stable. A full list of rating actions follows at the end of this release.

The upgrades reflect Macy's:

--Growing market share of the department store sector and stable to modestly higher share of the overall domestic apparel, accessories, footwear and home categories;
--Strong 14% EBITDA margins which are in line with its 'BBB+' rated peers, Nordstrom, Inc. and Kohl's Corporation;
--Strong free cash flow (FCF) which Fitch expects will be sustained at \$1 billion annually;
--Stable credit metrics, with adjusted debt/EBITDAR at 2.3x over the last three years. Fitch expects leverage to remain below 2.5x over the next 24 - 36 months, which provides Macy's flexibility to increase dividends in the 10%-15% range annually and do a healthy level of share buybacks in the range of 2014 levels.

KEY RATING DRIVERS

Driving Share Gains: Macy's, Inc. (Macy's) continues to drive market share gains in the mid-tier department store space with comparable store sales (comps) significantly and consistently outperforming its peers over the past four years. The company's strong operating momentum has benefited from its My Macy's localization initiatives, omnichannel offerings (Fitch estimates internet sales currently account for 12% of total sales), and strong customer service.

Macy's share of the department store segment has grown to 16.6%, gaining over 400 basis points from the 12.3% (using NAICS codes for department store industry sales) level over 2006 - 2009. Fitch expects Macy's will continue to take market share on annual top-line growth of 2% relative to Fitch's department store industry decline of negative 1% to negative 2%.

Looking at the overall larger domestic apparel, accessories, and home-related categories, Fitch expects a market consolidator would need to generate top-line growth of 2% or above to maintain market share versus other channels such as specialty, discount, and online. Macy's could generate this with relatively flat to modest comps growth at the store level and mid-teens growth from online sales, which would contribute roughly 200 bps to overall comps.

Macy's is a predominantly mall-based retailer and Fitch remains concerned about declining mall traffic over the next few years which may accelerate with significant operating weakness at some of its co-anchors (Sears, Bon-Ton, J.C. Penney). However, Macy's has had the financial capacity to and is making significant investments in its omnichannel offerings which has resulted in strong comps and continues to support its competitive positioning. Further, the company is focused on growth opportunities such as its recent acquisition of Bluemercury, Inc -- which Fitch expects to generate approximately \$100 million in annual revenue in 2015 through its high-end luxury beauty brands -- and exploring the off-price channel though the impact to the top line is likely to be modest in the near term.

A slight offset to revenue growth is the company's proactive closing of underperforming units, taking its store base to 823 units at the end of 2014, a reduction of 30 units since 2007. We expect Macy's could close 10 - 15 units annually going forward, in line with the 16 store closings announced in 2014. This level of store closing could hurt top line by 50 - 60 basis points but should be neutral to slightly positive to earnings longer term.

Stable Credit Metrics: Macy's generates strong operating margins, with EBITDA margin expansion of 150 bps over the last four years to 14.0% on strong top-line growth. Fitch expects EBITDA margins to be flat to modestly lower as Macy's continues to invest in its business to drive top line growth. Adjusted debt/EBITDAR was at 2.3x at the end of 2014 and Fitch expects adjusted debt/EBITDAR to remain below 2.5x over the next two to three years, assuming low single-digit growth in comps and EBITDA.

Strong Liquidity and Manageable Maturities: Liquidity remains strong, supported by a cash balance of \$2.2 billion as of Jan. 31, 2015, and a \$1.5 billion credit facility due May 2018. Fitch expects the company to refinance upcoming debt maturities and manage share buybacks within the context of maintaining adjusted leverage below 2.5x.

Strong FCF: Macy's annual FCF has ranged between \$1 billion to \$1.3 billion over the last four years and Fitch anticipates that Macy's can sustain annual FCF in the \$1 billion range over the next three years despite modestly higher capex levels. Fitch expects annual capex to be in the \$1.1 billion to \$1.2 billion range in the next two to three years as the company invests in its store base and continues to fund growth-related initiatives. Macy's does not currently need to fund its pension plan due to its strongly funded status at the end of 2014.

KEY ASSUMPTIONS:
--Comp store growth of 2% annually;
--EBITDA margin remains in the 14% range;
--Annual FCF sustained at \$1 billion;
--Adjusted debt/EBITDAR remains below 2.5x.

RATING SENSITIVITIES

A positive rating action could result if comps outperformance and share gains is sustained despite increasing pricing competition and promotional pressure in the middle market, while maintaining adjusted leverage under 2.0x. This is not anticipated at this time given Macy's publicly stated target of maintaining leverage in the 2.4x to 2.7x range.

A negative rating action could result in the case of a return to negative same-store sales trends and/or an aggressive financial strategy leading to leverage metrics increasing to the high 2x range on a sustained basis.

Fitch has upgraded Macy's, Inc. ratings as follows:

Macy's, Inc. (Macy's)
--Long-term Issuer Default Rating (IDR) to 'BBB+' from 'BBB';

Fitch takes the following actions on Macy's Retail Holdings, Inc. (MRHI):

--Long-term IDR to 'BBB+' from 'BBB';
--\$1.5 billion bank credit facility to 'BBB+' from 'BBB';
--Senior unsecured notes and debentures to 'BBB+' from 'BBB';
--Short term IDR affirmed at 'F2';
--Commercial paper affirmed at 'F2'.

The Rating Outlook is Stable.