Fitch Ratings Places Sears on Rating Watch Negative

Business Wire, Nov 17, 2004

CHICAGO -- Fitch Ratings has placed its ratings of Sears, Roebuck and Co. (Sears) and Sears Roebuck Acceptance Corp. (SRAC) on Rating Watch Negative following the company's announcement that it will be merging with Kmart Holding Corporation. Fitch currently rates Sears and SRAC's senior unsecured notes 'BBB-' and SRAC's commercial paper 'F3'. It is currently anticipated that upon completion of the transaction, the ratings could be downgraded two notches. Sears had $2.9 billion of domestic senior-term debt and approximately $800 million of commercial paper outstanding as of Oct. 2, 2004.

The Rating Watch reflects the risks associated with combining two underperforming retailers, uncertainty as to the new company's operating, financial and real estate strategies, and reduced financial flexibility as a result of the cash outlay required to complete the merger.

The $11 billion merger involves the exchange of shares, as well as the purchase of 45% of Sears' existing shares for a cash outlay of around $4.7 billion. While the two companies currently have in excess of $5 billion of cash on a combined basis, the purchase of the shares to complete the merger will greatly reduce the combined entities' excess liquidity.

Sears' operating performance year to date in 2004 is tracking well below Fitch's expectations, and operating weakness is expected to persist well into 2005. At the same time, Kmart continues to post sharp sales declines that will be difficult to reverse absent a significant investment in the company's stores and infrastructure. While the merged entity will enjoy some synergies, an operating turnaround will be complicated by the tepid pace of the economic recovery and growing competition from the discounters and big box specialty retailers.

As the combined entity rationalizes its real estate portfolio, it is expected that perhaps several hundred existing Kmart stores will eventually be converted to Sears stores. While this creates additional growth opportunities for Sears, it also places additional demands on Sears' management team at a time that it is attempting to improve the productivity and profitability of its existing stores. The company has indicated that it will monetize its excess real estate, though it is uncertain how it will apply the proceeds from those transactions.

Fitch will base future rating actions on an evaluation of the company's operating performance, real estate strategy, and target financial profile.