Fitch Upgrades Saks’ IDR to ‘B’ from ‘B-‘; Outlook Stable

NEW YORK–(BUSINESS WIRE)–Fitch Ratings has upgraded the Issuer Default Rating (IDR) of Saks

Incorporated (Saks) to ‘B’ from ‘B-‘. Based on Fitch’s recovery

analysis, the issue ratings on Saks’ $500 million senior secured bank

credit facility has been upgraded to ‘BB/RR1’ from ‘BB-/RR1’ and the

ratings on the senior unsecured notes have been upgraded to ‘BB/RR1 from

‘B/RR3’. The Rating Outlook is Stable.

The upgrades reflect the positive momentum in comparable store sales

(comps) trends since December 2009 and the improvement in EBITDA and

credit metrics relative to expectations. Fitch had previously assumed

that comps would remain negative through 2010 and as a result, Saks’

leverage would have likely been over 10 times (x). However, given comps

in the positive mid-single digit range over the last six months, latest

12-month (LTM) EBITDA for the period ended May 1, 2010 improved to $150

million versus $110 million in 2009 and $10 million in 2008, well above

Fitch’s expectations. Fitch expects adjusted debt/EBITDAR to improve to

around 5.0x in 2010 from 6.3x in 2009 and 13.0x in 2008, assuming

mid-single digit comps for the year.

For 2011 and 2012, Fitch expects the company to report low single digit

comps growth and as a result, credit metrics are expected to improve

modestly. This also assumes the company pays down $142 million of debt

due October 2011. At an EBITDA level of approximately $190 million and

total debt paydown of $175 million in 2010 and 2011 maturities, Saks’

leverage would return to a pre-recession level of 4.2x reported in 2007.

Embedded in Fitch’s sales expectation is a cautious outlook for the

luxury sector and while recent comps trends for the luxury department

store retailers have generally outperformed the broader department store

sector given very depressed sales levels in the year ago period, it is

still premature to determine a sustained level of sales growth for

2011/2012. Other concerns for Saks include the high volatility and

variability in sales and earnings; historically weak operating results

with sales productivity and profitability that is well below its two

closest industry peers; and the dependence on the flagship New York

store which accounts for approximately 20% of company sales but a higher

percent of profit given significantly higher sales per square foot.

Lower sales productivity at Saks’ stores over the last 10 years relative

to its two closest peers have kept operating margins at depressed

levels. For 2009, Saks’ average sales per square foot excluding its New

York flagship store was under $310 versus $370 at Nordstrom and $450 at

Neiman Marcus. As a result, EBITDA margin at Saks was 4.2% in 2009

versus 10.1% at Neiman Marcus and 14.4% at Nordstrom (excluding its

credit card business). Even pre-recession, Saks EBITDA margin at just

over 7% in 2007 lagged significantly behind mid-teen operating margins

for these two retailers. Before Saks was hit with the downturn in late

2008, the company appeared to be in the midst of a successful turnaround

through upgrading and broadening its merchandise mix, upgrading

technology and targeted investments in its stores. This had resulted in

superior comps performance from mid-2006 through mid-2008 and returned

the company to profitability in 2007.

With the downturn in late 2008, profitability came under significant

pressure on double digit sales declines. As a result, Saks was forced to

pull back on store level investments, primarily major and expensive

renovation projects, and expects 2010 net capital expenditures to be in

the range of $55 million versus $60 million in 2009 and $125 million

plus range for 2006-2008. Earlier this year, the company also announced

plans to close a handful of underperforming stores over the next couple

of years, with three store closings announced to date. Overall, Fitch

thinks the asset base is in good shape given the significant capital

infusion between 2006 and 2008 and the current level of capital spending

adequately addresses maintenance capital spending and some level of

remodeling activity.

The main challenge will be Saks’ ability to drive sustainable comps

growth and leverage fixed costs to improve profitability. Given the

recent downturn, the company has intensified its mix in the mid-price

points (or ‘good’ and ‘better’ price options), as have Neiman Marcus and

Nordstrom. The company has also focused on exclusives and private label

offerings, which currently account for less than 10% of sales but Saks

expects this could approach 20% over time. The main risk for the luxury

retailers is striking the right merchandising balance at various price

points and maintaining a consistent focus on the core luxury customer.

Saks has significantly improved its liquidity position over the last 12

months as a result of capital infusion and free cash flow generation of

$117 million in 2009. It amended and extended its $500 million credit

facility to November 2013 and bolstered liquidity through its $100

million equity offering in September 2009 and $120 million convertible

bond offering in May 2009. As of May 1, 2010, the company had

approximately $180 million in cash and no borrowings under its $500

million credit facility. Fitch expects free cash flow of approximately

$25-$30 million in 2010 and in excess of $50 million in 2011 and 2012.

As a result, Fitch expects that Saks can pay down debt maturities of $23

million in December 2010 and $142 million in October 2011 with cash on

hand.

The ratings on the company’s $500 million secured bank facility and the

senior unsecured notes are derived from the IDR and the relevant

Recovery Rating (RR). Fitch’s recovery analysis assumes a liquidation

value in a distressed scenario of approximately $1 billion. This is

based on a 50% liquidation value for inventory and about $640 million

(or 70% of book PP&E) for owned real estate based on dark store

valuation analysis. Saks owns 68% of its full-line square footage,

including its Fifth Avenue New York City store, which remains

unencumbered.

Applying the $1 billion liquidation value for Saks across the capital

structure results in outstanding recovery prospects (over 90%) for its

$500 million revolving credit facility and its unsecured notes, which

are therefore rated three notches above the IDR at ‘BB/RR1’. The $368

million value assumed in Fitch’s recovery analysis for the senior

secured credit facility reflects a borrowing base of $456 million as of

May 1, 2010, adjusted for $87.5 million. While the fixed charge coverage

ratio was above 1.0x at May 1, 2010, Fitch assumes that under a stress

case scenario, the fixed charge coverage would most likely to be under

1.0x and the company would therefore not have access to $87.5 million of

availability.

The senior credit facility which is due to mature in November 2013 is

secured by inventories and certain receivables. Borrowings are limited

to a prescribed percentage of eligible inventories and receivables. The

facility is not subject to any financial covenants unless the

availability falls below $87.5 million. At that time, it is subject to a

fixed charge coverage ratio of at least 1:1. The facility, which was

amended in November 2009, provided more flexibility in terms of debt

incurrence and asset sales. The amended facility provided a carveout to

sell or otherwise encumber up to $400 million of real estate during the

term of the agreement. In addition, the company can sell up to $50

million worth of assets (and 50% of the unused portion from the prior

year) per year, and up to $250 million in aggregate. Saks can also incur

debt to purchase fixed assets; incur up to $100 million of debt maturing

prior to the expiration date of the credit facility related to

acquisitions, and other unsecured debt of up to $200 million. The

company also increased the percent of voting stock that would constitute

a change of control (and trigger an event of default) from over a 20%

ownership to over 40%. The facility contains a provision that would

trigger a default of the facility if a default were to occur in another

debt instrument resulting in the acceleration of principal of more than

$20 million in that instrument. The senior unsecured notes contain

limitations on the amount of secured indebtedness the company may incur.

These rating actions reflect the application of Fitch’s current criteria

which are available at ‘www.fitchratings.com

and specifically include:

–‘Fitch Ratings’ Process for Reviewing Existing, Updated and New

Criteria, Models, and Securities’, dated Dec. 16, 2009;

–‘Corporate Rating Methodology’, dated Nov. 24, 2009;

— ‘Recovery Ratings & Notching Criteria for Nonfinancial Corporate

Issuers’, dated Nov. 24, 2009;

–‘Operating Leases: Updated Implications for Lessees’ Credit’, dated

Aug. 13, 2009;

–‘Evaluating Corporate Governance’, dated Dec. 12, 2007;

–‘Liquidity Considerations for Corporate Issuers’, dated June 12, 2007.

Additional information is available at www.fitchratings.com.

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