OREANDA-NEWS. Sears' intention to obtain a new senior first-lien secured term loan facility of up to $750 million due 2020 does not improve the company's liquidity position versus 2015 or change its credit story, according to Fitch Ratings. However, the $750 million new term loan will help to offset the April 2016 reduction of the credit facility during the third quarter peak borrowing season.

Proceeds from the term loan will have to be used to reduce borrowings under its $3.275 billion asset-based revolving credit facility as the company's 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 - has been limited given the significant reduction in working capital over the past few years.

This has been exemplified over the past few quarters with total availability under its $3.275 billion revolver restricted to $1.8 billion in the fourth quarter of 2015 (and $2.3 billion at seasonal working capital peak at 3Q15) after the effect of the springing fixed charge coverage ratio covenant and the borrowing base limitation.

However, Fitch notes that the current credit facility size is $3.275 billion until April 2016, at which point $1.304 billion will expire and $1.971 billion will extend until 2020. The issuance of the $750 million term loan would ensure that at seasonally peak working capital needs around the holiday season, Sears' liquidity between the downsized credit facility of $1.971 billion and the $750 million term loan at around $1.8 billion (after giving effect to minimum excess availability and $650 million in letters of credit outstanding) remains essentially unchanged to third quarter 2015.

Key Rating Drivers
Sears reported 2015 EBITDA of negative $837 million on negative comparable store sales of 9.2%. Fitch expects comps to be in the negative mid-single digit range in 2016 and 2017, with top-line declining potentially in the high single-digit range as Sears continues to close stores. As a result, Fitch expects 2016 EBITDA to be in the negative $800 million to $1 billion range, even assuming cost reductions as targeted of $550 million to $650 million.

Significant Cash Burn: Sears' 2015 year-end liquidity was approximately $550 million, comprised of $238 million in cash plus availability under its domestic credit facility of $316 million. This is in spite of raising $3.1 billion through asset sales in 2015.

$2.2 Billion to $2.5 Billion Liquidity Needed in 2016: Sears' interest expense, capex and pension plan contributions are expected to total $800 million annually in 2016 and 2017. Together with Fitch's negative EBITDA expectation and assuming no material swings in working capital leads to cash burn (CFO after capex and pension contributions) of $1.6 billion-$1.8 billion in 2016.

Sears also needs to fund seasonal working capital needs with inventory expected to range from $6.0 billion-$6.2 billion at holiday peak from $5.2 billion at the end of the fourth quarter of 2015 (4Q15). This suggests $550 million to $700 million is required to fund working capital assuming payables to inventory ratio of 30%-35%, which can be funded between the $2 billion credit facility and the new term loan. Therefore, post the $750 million term loan issuance, the company would still need to raise $1.5 - $1.75 billion to fund 2016 operations.

Shrinking Assets Fund Operations: Sears injected $3.1 billion in liquidity in 2015, with $429 million from real estate joint ventures (JVs) related to 31 stores and $2.7 billion from the sale-leaseback transaction with Seritage Growth Properties (Seritage), in which it sold 235 owned properties and its 50% interest in the JV. This is on top of the $6.8 billion (including 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.

Potential Sources of Liquidity: Sears still owns and could monetize 268 unencumbered Kmart discount and Sears full-line mall stores (this excludes 125 Sears full-line mall stores in a bankruptcy-remote vehicle and 26 specialty 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 generate an additional $2.6 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. The company could also separate its Sears Auto Center business.

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.

Fitch currently rates Sears as follows:

Sears Holdings Corporation
--Long-term Issuer Default Rating (IDR) 'CC';
--$302 million second-lien secured notes 'CCC+/RR1';
--$625 million unsecured notes 'C/RR6'.

Sears, Roebuck and Co.
--Long-term IDR 'CC'.

Sears Roebuck Acceptance Corp.
--Long-term IDR 'CC';
--Short-term IDR 'C';
--Commercial paper '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) 'CCC+/RR1' (as co-borrower);
--$980 million first lien term loan 'CCC+/RR1' (as co-borrower);
--Senior unsecured notes 'CC/RR4'.

Kmart Holding Corporation
--Long-term IDR 'CC';

Kmart Corporation
--Long-term IDR '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) 'CCC+/RR1' (as co-borrower);
--$980 million first lien term loan 'CCC+/RR1' (as co-borrower).