The long- and short-term term issuer credit rating was lowered to “BB+” and “B” from “BBB-” and “A-3,” respectively, while the retailer’s senior unsecured debt was lowered to “BB+” from “BBB-“.
“The downgrade reflects our view that Macy’s improvement trajectory is weaker than our prior expectations and execution risks are elevated as the company pursues its Polaris strategic plan against an ongoing difficult industry backdrop,” Andy G. Sookram, lead credit analyst, said.
In Sookram’s opinion, the retailer faces unique challenges stemming in part from a history of acquisitions that has saddled it with excess stores. “While we believe management’s strategic plan is a necessary step toward rightsizing the enterprise, it demonstrates to us that the company’s competitive advantage has diminished more than we expected, and to a point that we no longer believe is consistent with an investment-grade rating,” he said.
Sookram and other credit analysts at S&P now expect operating performance at Macy’s will deteriorate over the next several quarters, with declines in comparable same-store sales. “However, we recognize the company’s ability to manage credit metrics by reducing debt with still good free cash flow generation, supplemented by asset-sale proceeds,” Sookram said.
While the Polaris strategy includes meaningful restructuring and a renewed focus on loyalty programs, private labels and e-commerce, the ability to implement successfully will be a challenge due to increasing competition from retailers that are ahead in many of those areas, Sookram said, citing The TJX Stores Inc. as a destination for bargains and Target Corp. for quality private-label brands.
“We believe the strategy highlights Macy’s need to transform itself into a department store that is more relevant to today’s shopper, which will be especially difficult given its large footprint and weakening competitive position,” Sookram said.
While cost-cutting initiatives in merchandising and supply chain capabilities and in corporate expense rationalization will help the retailer offset margin headwinds, the bigger and longer-term risk is “further deterioration of the business because of mounting competitive pressures, rapidly changing consumer shopping preferences [such as secondhand apparel purchases], and the potential for operational missteps,” Sookram said. “As a result, we have revised our business risk assessment to fair from satisfactory.”
Adding to the challenges are the credit analyst’s expectations that growth in Backstage stores and partnership efforts probably won’t garner any significant benefits “any time soon,” while more store closures are likely to follow if weaker malls continue to see traffic deteriorate.
The Polaris plan sees Macy’s top 250 stores representing 78 percent of sales by 2021. But the S&P analysts noted that as of year-end 2019, Macy’s top 150 stores carried about 50 percent of store revenues, with many of its stores located in lower-traffic malls. That’s in contrast with peers such as Nordstrom, which has the majority of its stores in Class A malls.
“We continue to expect rivals, including discounters, other off-price retailers, and online companies to take market share from department store operators. Same-store sales at peers demonstrated an improving trend during the first three quarters of 2019, while Macy’s sales trended lower,” Sookram said.
The current outlook is “stable,” reflecting the view that cost-savings initiatives should offset sales declines. Operating cash flow is considered solid at $1.3 billion annually.
“We view the successful execution of its core retail offering becoming increasingly important as asset sale proceeds have been declining,” the credit analyst concluded.
Macy’s has $300 million of cash on hand as of Nov. 30, 2019, full availability under the $1.5 billion revolving credit facility and funds from operations of $1.5 billion in each of the next two years. The retailer has capital expenditures of around $1 billion annually, dividend payments of $460 million to $470 million, and manageable debt maturities of $530 million in 2020, according to an S&P Global Ratings report.