DBRS Confirms Federated Retail Holdings, Inc. at BBB and R-2 (middle)

Dominion Bond Rating Service (DBRS) has today confirmed the ratings of Federated Retail Holdings, Inc. (Federated or the Company), the wholly owned operating subsidiary of Federated Department Stores, Inc., Senior Unsecured Debt at BBB and Commercial Paper at R-2 (middle).The trend is Stable.

The ratings reflect the steady progress in earnings and cash flow in Federated’s legacy operations as well as the increasing geographic diversification of the company resulting from the 2005 merger with The May Department Stores Company (May).

The ratings also reflect the increased leverage resulting from the merger; the challenges of integrating May’s operations and achieving financial results from those operations that are consistent with Federated’s historical results; as well as the loss of ongoing income from the financial services division, which has been disposed of to fund the merger.

Federated has established a national upscale department store chain with operations in most key markets of the United States. Geographic diversification provides a degree of protection from regional economic challenges. The merger with May also provides increased opportunity to use national promotions and advertising, increased ability to develop and promote private label products and increasing clout with suppliers. Federated’s primary banners, Macy’s and Bloomingdale’s, are among the strongest and best-known names in retailing.

Notwithstanding these strengths, Federated faces four key challenges:

First, consumer tastes change rapidly, and a fashion-oriented retailer must remain near the forefront of style trends.

Second, the department store business is highly competitive, with strong competition from other department stores as well as specialty retailers, category killers and big-box retailers.

Third, merger integration risk is significant. Federated commenced converting the various May banners to Macy’s in September 2006. These conversions run the risk of alienating customers who are loyal to the former banners. This risk is substantially offset by the possibility of attracting new customers through the introduction of enhanced private-label and exclusive product lines.

Fourth, sales in the department store channel are essentially flat. As such, profitability growth is primarily derived from expense reductions and operational efficiencies.

Improvement in the financial profile in the medium term is expected to be moderate as the company invests capital in converting May stores to new banners and invests in extensive promotions to establish the new branding. DBRS expects increases in profitability to begin in F2007 and to strengthen in subsequent periods. Should these improvements not occur, ratings could come under pressure.

Note:
All figures are in U.S. dollars unless otherwise noted.