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Fitch Affirms Target Corporation at 'A-'; Outlook Revised to Negative
March 1, 2017 / 3:05 PM / 9 months ago

Fitch Affirms Target Corporation at 'A-'; Outlook Revised to Negative

(The following statement was released by the rating agency) CHICAGO, March 01 (Fitch) Fitch Ratings has affirmed the Long-term Issuer Default Rating (IDR) on Target Corporation (Target) at 'A-' and the Short-term IDR at 'F2'. The Rating Outlook has been revised to Negative from Positive. The Outlook revision acknowledges the accelerated impact of changes in consumer shopping preferences on Target's near-term results and the significant investments required to stabilize market share over the longer term. Competition from online only and discount peers have pressured Target's comps yielding market share and EBITDA erosion. As a result, the company has been forced to accelerate investments in omnichannel initiatives and tighten its focus on pricing and merchandising assortments. Fitch has reduced confidence in Target's ability to maintain or grow market share over the long run, given online encroachment in many of its categories and Target's pricing perception at the upper end of the discount sector. A downgrade could occur if the company does not exhibit signs of comp stabilization by second half 2018. KEY RATING DRIVERS Negative Comp Trajectory: Comps have been negative for three consecutive quarters, declining 1.5% in 4Q16 and 0.5% for the fiscal year ended January 2017. While digital sales have increased significantly to $3.4 billion in 2016 from $1.4 billion in 2014, they still represent less than 5% of overall sales and have not been enough to offset in-store comp declines, which declined 1.5% in 2016. Fitch expects comps to decline 2.5% to 3% in 2017 and 1% to 1.5% in 2018 as Target's recently announced strategic initiatives to improve pricing perception and merchandise assortment are implemented. The company's outsized exposure to categories experiencing significant on-line intrusion and relatively low exposure to food, which drives repeat transactions, are risks in stabilizing store traffic and transactions. Increased Investments Pressure EBITDA: Target's gross margin declined 100 bps to 26.9% during 4Q16 due to promotional activity and negative mix shift caused by an increase in lower margin digital sales. While Target's EBITDA (adding back non-cash stock-based compensation expense) margin improved 50 bps to 10.6% in 2016 due to cost savings associated with the company's two-year $2 billion cost savings program and the sale of its pharmacy business, Fitch expects EBITDA margin to decline to the mid-9% range in 2017 and 9% in 2018 as the company continues to see pressure from channel shift towards digital, makes investments in price, picks up the pace of remodeling and opens new urban stores, and introduces a dozen new private brands. Fitch projects EBITDA declines in the mid-teens in 2017 to $6.5 billion and 8% to 10% in 2018 to $6 billion. Higher Capex, Lower FCF: In addition to investments in price, Target also intends to increase capex to support its network of physical and digital assets. Capex is projected to increase to over $2 billion in 2017 from approximately $1.5 billion in 2016 due to remodeling stores and technology and supply chain investments to modernize its operations and to support flexible fulfillment. Fitch expects FCF after dividends in the $1 billion to $1.5 billion range in 2017 and $750 million range in 2018, down from over $2.5 billion in 2016, due to lower earnings, higher capex, and the company's modestly increasing dividend. Leverage Expected to be in the Low 2x range: Target's adjusted leverage declined from the mid-2.0x range during the 2011 to 2013 period to 1.9x at the end of 2016 due to a combination of debt paydown following the sale of its credit card business and operating income growth through 2015. Fitch projects total adjusted debt/EBITDAR will be in the low 2.0x range in 2017 and 2018. Target has roughly $600 million of 5.375% notes due May 2017 and $1.1 billion of 6% notes maturing January 2018. Target could choose to pay down a portion or all of these debt maturities in 2017 to maintain adjusted debt/EBITDAR at the 1.9x level reported in 2016. In addition, Fitch expects Target to significantly pull back on net share buybacks from the $3.5 billion level in 2016. KEY ASSUMPTIONS Fitch's key assumptions within its rating case for the issuer include: --Total revenue declines at 2% to 2.5% in 2017 and -1% in 2018; --EBITDA declines in the mid-teens in 2017 to $6.5 billion and 8%-10% in 2018 to $6 billion, with EBITDA margin declining to around 9%; --FCF after dividends approximates $1 billion to $1.5 billion range in 2017 and $750 million range in 2018; --Total adjusted debt/EBITDAR is in the low 2.0x range, assuming the company pulls back significantly on share buybacks. RATING SENSITIVITIES Target's Outlook could stabilize if it gains traction on its strategic initiatives, with signs of stabilizing comps by second half 2018 and EBITDA stabilizing around $6 billion (versus $7.4 billion in 2016), while maintaining leverage around 2x. Positive Rating Action: Factors that could individually or collectively lead to an upgrade to 'A' include consistently strong operating momentum, represented by sustained comparable sales (comps) of approximately 2% or more with positive transaction growth and an EBITDA margin above 10%, and total adjusted debt/EBITDAR sustained under 2.0x. Negative Rating Action: Factors that could individually or collectively lead to a negative rating action include the continuation of negative comps beyond 2018, EBITDA margins declining to mid-8% range, and continued share repurchases that drive total adjusted debt/EBITDAR towards the mid-2.0x range. LIQUIDITY Strong Liquidity: As of Jan. 28, 2017, Target had cash of $2.5 billion and a $2.5 billion unsecured credit facility, which expires in October 2021 (this recently replaced an existing $2.25 billion facility maturing October 2018). Fitch expects FCF after dividends to approximate $1 billion to $1.5 billion in 2017 and $750 million range in 2018, assuming neutral working capital. This compares to FCF of $2.5 billion in 2016. FULL LIST OF RATING ACTIONS Fitch has affirmed the following ratings: Target Corporation --Long-term IDR at 'A-'; --Senior unsecured notes at 'A-'; --Short-term IDR at 'F2'; --Commercial paper at 'F2'. The Outlook has been revised to Negative from Positive. Fitch has also assigned the following rating: --Bank Credit Facility due 2021 'A-'. Contact: Primary Analyst Carla Norfleet Taylor, CFA Senior Director +1-312-368-3195 70 W. Madison St. Chicago, IL 60473 Secondary Analyst David Silverman, CFA Senior Director +1-212-908-0840 Committee Chairperson Monica Aggarwal, CFA Managing Director +1-212-908-0282 Media Relations: Elizabeth Fogerty, New York, Tel: +1 (212) 908 0526, Email:; Hannah James, New York, Tel: + 1 646 582 4947, Email: Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below: Historical and projected EBITDA is adjusted to add back non cash stock based compensation and non-recurring benefits or charges. In 2016, Fitch excluded a net of $4 million benefit related to the Pharmacy transaction and added back $113 million in non-cash stock based compensation to its EBITDA calculation. 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