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Sears Gets Credit Downgrade, Fitch Says Cash May Not Carry Retailer Through 2016

Ailing Sears has been battling to stay afloat, but credit ratings agency Fitch Ratings doesn’t think the retailer will have enough funding to continue operations beyond 2016.

Fitch downgraded Sears Holdings Corporation’s credit rating Wednesday to “CC” from “CCC” because of the “magnitude” of its decline in profitability and considerable cash burn.

Sears Holdings’ EBITDA (earnings before interest, taxes, depreciation, and amortization) is expected to be a negative $1 billion in 2014, after turning negative $337 million in 2013, and the decline could even be worse next year.

Fitch said it expects the retailer to see top-line contraction around 9 to 10 percent in 2014 owed to estimated domestic comparable store sales of negative 1 to 2 percent, and store closings are expected to continue. And the ratings agency does not expect any catalysts in the business to quell the rate of decline.

Another area of major concern was Sears’ cash burn, which Fitch expects to be around $2 billion or higher annually. The retailer’s funding options may also not be enough to support operations past 2016 given the significant cash burn—Fitch said Sears needs to generate a minimum of $1 billion in earnings before taxes, interest and other items annually between now and 2016 to cover its expenses, a far reach from the negative $1 billion Fitch is projecting.

Selling assets like its 51 percent interest in Sears Canada, which the retailer has been exploring, could be a potential source of much-needed liquidity as could issuing debt, though it is subject to borrowing base requirements.

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In response to the Sears downgrade, a spokesperson for the company said, “We don’t agree with their action given our demonstrated history of honoring our financial commitments while continuing to invest in our transformation. We have proven that we have an asset rich portfolio that provides us with what we believe to be substantial financial flexibility.”

For its second quarter ended Aug. 2, 2014, Sears Holdings net loss was $573 million compared to $194 million in the prior year period. Sears full line stores’ comparable store sales grew 0.1% for the quarter, and Kmart comparable store sales were down 1.7%.

Sears Holdings CEO Edward Lampert said of the quarterly earnings statement, “Our second quarter earnings are unacceptable and we are taking steps to address our performance on several levels. This includes reducing costs as we evolve our business model, investing in our Shop Your Way and Integrated Retail customer initiatives, rationalizing our physical footprint and improving pricing and promotions.”

The company owned 367 full line Sears stores, 183 Kmart discount units and 12 Kmart supercenters at the end of 2013, and this real estate backed debt could be a potential source of liquidity for the retailer. “Sears could seek to do a real-estate backed transaction that could potentially be in the range of $2.0-$2.5 billion using a similar approach to valuing the real estate that was used by J.C. Penney to raise a $2.25 billion term loan in May 2013. However, the significant deterioration in Sears business and the lack of visibility on a turnaround could limit this option. This does not contemplate a series of small real estate transactions that could also involve landlords assuming some of Kmart’s and Sears’ leases in highly productive malls,” according to Fitch.

But even if Sears could execute on some of these liquidity options and generate $4 to $6 billion in proceeds, the retailer would only make it through 2016, according to Fitch, which also noted that the risk of restructuring will be high over the next two years.

The downgrade hasn’t yet spooked investors as Sears’ shares closed Wednesday up 2 percent to $33.57 and were up nearly 3 percent to $34.57 at the time of publication.