S&P Global Ratings raised the debt ratings on Dillard’s, Inc. as the department store chain maintained a “stable performance and a conservative financial policy even in the volatile retail operating environment of the past year.”
S&P expects Dillard’s leverage will remain limited over the coming year, providing a significant cushion to absorb near-term performance softness in a potentially recessionary economic environment. The retailer’s issuer rating was lifted to ‘BB+’ from ‘BB-‘.
The stable outlook reflects S&P’s expectation for sustained profitability and Free Operating Cash Flow (FOCF), attributable to the company’s strong inventory management and limited discounting relative to peers.
S&P said in its analysis, “The upgrade reflects our expectation that Dillard’s store ownership, minimal balance sheet debt, and good merchandise execution will help navigate potential declines in consumer demand this year. The company’s fiscal 2022 performance significantly exceeded our expectations, and we now believe it will largely sustain these gains. We note Dillard’s management team has strategically employed operating initiatives that have helped maintain growth and achieve robust EBITDA margins. For example, it has taken a disciplined approach to inventory management to limit promotional activity. Dillard’s year-over-year inventory balance increased 4 percent, while many competitors were up double-digit percent this year. This leads us to revise our forecast for sustained adjusted EBITDA margins to the low- to mid-teens percent area from the high-single-digit percent area. Still, our forecast incorporates significant moderation in recent performance (adjusted EBITDA margins were 18 percent in the latest fiscal year) given higher labor costs and slowing demand. Our base case incorporates a shallow recession in the second and third quarters of 2023.
“This marked improvement in profitability led to S&P Global Ratings-adjusted leverage of 0.6x at fiscal year-end 2022. As a result of the revised business risk assessment to fair from weak, we now net cash against debt in our adjusted leverage calculation. Dillard’s capital structure includes only an $800 million secured revolving credit facility, about $320 million of unsecured notes, and $200 million of subordinated debentures. Given that plus about $650 million cash, we now forecast the company will end 2023 in a net cash position. This is by far the lowest leverage of the department stores we rate. We believe its rapidly improved profitability and increasing track record of operational success reflect an improved competitive standing within its regional markets.
“We expect Dillard’s management to maintain a conservative financial policy. The company has historically operated with low-funded debt, and we believe this policy will continue to absent a change in controlling ownership. We project that Dillard’s will be in a net cash position at fiscal year-end 2023, effectively zero adjusted leverage. Moreover, we expect S&P Global Ratings-adjusted leverage will remain well below 1x even if it pursues additional share repurchases or special dividends. Dillard’s returned about $724 million to shareholders in 2022 through internally generated cash flow. We expect it will continue to utilize excess cash for shareholder returns. This is supported by our forecast for roughly $600 million of annual FOCF. Given our revised forecast for very low leverage and healthy FOCF, offset by volatility in recent years’ performance, we revised our financial risk assessment to modest from intermediate.
“We also note that Dillard’s owns the real estate for about 90 percent of its stores, with a book value of over $1 billion. We view its substantial asset ownership as strategic, providing operating and financial flexibility. Under current management and family control, we expect the company to maintain its real estate ownership and a conservative approach to debt.
“We believe Dillard’s remains exposed to disruptive sector trends as a regional department store retailer. Apparel purchases are highly discretionary, and we expect performance will remain vulnerable to economic conditions such as the recent macroeconomic slowdown. In addition, declining physical store traffic, shifting category preferences, and online price transparency are persistent longer-term risks for Dillard’s business. We believe omnichannel capabilities are an important competitive factor given customers’ continued rapid adoption of e-commerce. The leading national department store chains continue to strengthen their omnichannel capabilities through accelerated investments in digital storefronts.
“Despite a strong 2021 and 2022, Dillard’s has historically had lower margins than national peers due to its smaller footprint. In addition, it has an uneven operating track record. Profitability deteriorated significantly with adjusted EBITDA margins of less than 7 percent before the pandemic in fiscal 2019, declining nearly half since 2015 due to merchandise missteps. Notwithstanding its recent operating successes, we believe changing consumer apparel buying habits will be difficult to navigate, which increases the potential for operational missteps. Therefore, we continue to apply a negative comparable rating modifier to capture this standing in relation to its ‘BBB-‘ rated peers.
“The stable outlook reflects our expectation that adjusted EBITDA margins will come down to the low- to mid-teens percent area, but remain several hundred basis points above pre-pandemic levels. It also reflects our expectation for a conservative balance sheet, supported by consistent and good annual FOCF of more than $600 million. We see the potential for internally funded special dividends or share repurchased based on relatively large cash balances.”
Photo courtesy Dillard’s Northlake Mall
