OREANDA-NEWS. Fitch Ratings has assigned a rating of 'BBB+' to Macy's Retail Holdings' $500 million issue of 5-year senior unsecured notes.

The proceeds from the issue will be used to refinance 2016 debt maturities (with $636 million due to mature). Leverage at year-end 2015 is expected to be 2.7x, above Fitch's expectations of 2.3x-2.4x (made at the beginning of this year), given the weak operating trends year to date (YTD). Operating EBITDA is expected to decline 13% in 2015 to $3.5 billion on a comparable store sales decline of 2% (including licensed departments). This year has been challenging for the whole sector given weaker than expected demand for apparel and a slowdown in tourism due to the strong dollar that has hurt Macy's in its key markets.

The 'BBB+' rating incorporates Fitch's view that Macy's will drive share gains over the intermediate term and our expectation that the company will refinance upcoming debt maturities and manage share buybacks within the context of maintaining adjusted leverage at or below 2.5x. The continuation of the weak YTD operating trends into 2016 and/or a more aggressive financial policy would result in a negative rating action.

KEY RATING DRIVERS

Market Position: 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. While comps have declined YTD and are expected to decline 3% in the fourth quarter, Fitch expects Macy's to hold its solid position over the medium term given localization initiatives, omnichannel offerings (we estimate internet sales currently account for 12% of total sales), and strong customer service. Macy's would need to return to comp growth levels of 2%-3% to maintain its overall share of the apparel, accessories and home categories in which it operates.

Macy's is a predominantly mall-based retailer and Fitch remains concerned about mall traffic declining over the next few years, which may accelerate with significant operating weakness at some of its co-anchors. However, Macy's has the financial capacity to and is making significant investments in its omnichannel offerings - fast-growing acquisitions such as Bluemercury, Inc, and new off-price format, though the impact will be modest in the near term. In addition, revenue growth is being dampened somewhat by the company's proactive closing of underperforming units, although Fitch views the store closings as necessary given the secular headwinds.

Strong Liquidity and Manageable Maturities: Liquidity remains strong, with cash balances expected to be in the $1.7 billion to $1.8 billion range at the end of 2015, and supported by a $1.5 billion credit facility due May 2018.

Macy's annual free cash flow (FCF) has ranged between $1 billion to $1.3 billion over the last four years. Fitch anticipates FCF in 2015 will decline to the positive $0.5 billion range given the anticipated decline in EBITDA and working capital being a potential use of funds given weak top-line trends. Should top-line trends return to positive in the low single-digit range, Fitch expects Macy's can sustain annual FCF at around $1 billion despite modestly higher capex levels. Macy's does not currently need to fund its pension plan due to its strongly funded status at the end of 2014.

KEY ASSUMPTIONS:
--Negative comp store growth of 2% in 2015 but in the positive 2% range annually thereafter;
--EBITDA decline of 13% in 2015 to $3.5 billion but recovers to $4 billion over the next 18-24 months with EBITDA margins returning to 13.5%-14% (versus under 13% in 2015);
--FCF of $0.5 billion in 2015 given weak operating trends but sustained at $1 billion annually thereafter;
--Adjusted debt/EBITDAR increases to 2.7x in 2015 but returns to the low-to-mid-2x range beginning 2016.

RATING SENSITIVITIES
A positive rating action could result if comps outperformance and share gains are 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 2.5x to 2.8x range (based on its calculation of using 9.3x rent expense for capitalizing leases).

A negative rating action could result if Macy's does not return to positive low-single-digit comps trends and/or pursues an aggressive financial strategy leading to leverage metrics increasing to the high 2x range on a sustained basis.

FULL LIST OF RATING ACTIONS

Fitch currently rates Macy's, Inc. as follows:

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

Macy's Retail Holdings, Inc. (MRHI):

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

The Rating Outlook is Stable.