Fitch: Sears' Liquidity Worsens with $2.5B Needed to Fund Operations in 2016

Today Sears preannounced its fourth quarter results with projected 2015 EBITDA of negative $750 million to $800 million, about $150 million worse than previously expected by Fitch Ratings.

This reflects the company's first negative fourth quarter EBITDA, projected at negative $50 million to $100 million on negative comparable store sales of 7.1%. Fitch expects comps to remain 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' year-end liquidity was approximately $1.4 billion worse than anticipated, with total cash and revolver availability of approximately $550 million, comprised of $238 million in cash plus availability under its domestic credit facility of $316 million.

This is relative to Fitch's expectations of $1.8 billion to $2 billion in liquidity at year-end given that the company had raised $3.1 billion through asset sales in the first nine months of the year. With an EBITDA shortfall of $150 million relative to expectations, the material decline in liquidity suggests that working capital could have been a use of funds in 2015 (relative to $300 million to $400 million contribution over the past four years as the company has cut back on inventory buys and closed/sold assets), and there could have been other material cash charges.

$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 approximately $5 billion at year end to $6.0-$6.2 billion at holiday peak. This suggests $700 million to $850 million is required to fund working capital assuming payables to inventory ratio of 30%.

Shrinking Assets Fund Operations: Sears injected $3.1 billion in liquidity through October 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 approximately 269 unencumbered Kmart discount and Sears full-line mall stores (this excludes 125 Sears full-line mall stores in a bankruptcy-remote vehicle and 27 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.

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 -- is 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 million 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.

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);

--$979 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);

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

Additional information is available on www.fitchratings.com.

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