While economic factors will impact lower income consumers more significantly than those at higher income levels, consumers at all but the highest income levels are expected to moderate discretionary spending with fewer aspirational purchases and more trading down among retail channels.

Rating company Fitch Ratings is reiterating what other experts have been saying for months - expect a moderately weaker 2007 holiday season compared to last year with weakness continuing in 2008.

Fitch anticipates that comparable store sales growth in 2008 will be weaker than 2007 levels due to slow U.S. GDP growth, which Fitch forecasts to be about 1.7% in 2008, versus an expected 1.8% in 2007. Expected high energy costs, weak housing and credit markets, and increased unemployment rates will weigh on consumer confidence and spending. While these factors will impact lower income consumers more significantly than those at higher income levels, consumers at all but the highest income levels are expected to moderate discretionary spending with fewer aspirational purchases and more trading down among retail channels. As a result, competition among retailers is anticipated to remain intense, particularly in those geographic markets that are most acutely impacted by housing and job related weakness. The combination of pressured revenues, promotional activity, and high costs related to energy and commodities are expected to stress operating profit margins.

Fitch expects retailers will be primarily focused on perfecting their operating strategies in order to preserve sales and gain market share as well as manage profitability and cash flow generation. A clear demarcation between the strong and weak operators will become apparent in 2008 and, over time further retail consolidation will occur as strong operators accelerate their share gains and weaker operators get rationalized out of the market. In addition, depressed stock prices and a weak U.S. dollar could encourage further share repurchase and foreign-led acquisition activity. However, the level of this activity will be significantly below that of the last three years and in general, Fitch expects companies to manage their capital structure initiatives within the context of a more challenging operating environment.

Of importance is that liquidity for U.S. retail companies is expected to remain strong and be primarily internally generated. External sources of liquidity such as new debt issuance and bank facilities remain available, particularly for investment grade companies. In 2008, refinancing activity is expected to be below the $10.8 billion of debt maturities. However, additional debt financing related to Home Depot's $22.5 billion share repurchase program and Target's review of its capital structure and credit card business is possible. Overall, Fitch views the U.S. retail industry as having more downside rating risk than upside rating potential as supported by the ratio of Negative Rating Outlooks and Rating Watches relative to Positive Rating Outlooks and Watches of 5:3.

Fitch expects companies will need to be focused on managing their business to drive traffic into stores, contain costs, and appropriately allocate cash flow.

Spurring Top Line Growth Through Unique Brands And Strong In-Store Execution:

Retailers with well defined and executed operating strategies around merchandise, pricing, stores and service will further differentiate themselves from weaker peers in 2008. Strategies retailers will use to drive top line growth include:

--Private brands, which create a compelling value proposition for consumers as they may be priced more competitively than similar national brands or possess unique attributes;

--Exclusive brands and limited editions, such as Kohl's Simply Vera Vera Wang merchandise, which create excitement, drive store traffic and promote full price buying; and

--Superior in-store experience and service levels to build customer loyalty, particularly for commoditized merchandise categories.

Controlling costs will be a key area of focus to offset margin compression from top line pressures and promotional activity as well as high energy and commodity costs. As a result, retailers are expected to focus on inventory management, supply chain efficiencies and labor productivity. However, as many operators have already realized benefits from these areas over the last few years, it may be difficult to fully offset margin pressures.

Fitch expects a lower level of leverage financed mergers and acquisitions and share buyback activity in the U.S. retail sector in 2008 versus 2007 given tightened credit market conditions. In addition, retail companies are anticipated to use cash flow generation to fund capital expenditures and strengthen store operations while reducing cash flow focused on shareholder returns if necessary. This was the case following the Southern California supermarket strike in 2003/2004 when both Safeway and Kroger used cash flow to invest in core operations and lower debt levels while reducing share repurchase activity. However, low stock prices and a weak U.S. dollar could encourage further share repurchase or acquisition activity by strategic or foreign buyers.

Fitch expects sales of discretionary goods, particularly in home related and apparel categories, to remain challenged while staples, such as food and prescriptions, show relative strength.

Discounters:
Food and consumables will continue to drive store traffic for discounters but consumers, particularly those with lower income levels, will become more selective in their spending and limit their purchases of non-essential items. As a result, discounters will focus on competitive pricing and customer service to drive sales. Furthermore, Fitch expects operating profit margins to remain relatively steady as discounters manage their cost structures. Discounters, such as Target and Costco, that cater to higher income consumers will fare better than companies, such as Wal-Mart, that cater to lower income customers. Store base expansion will continue; however, Wal-Mart is slowing its pace of store growth to 5% to 6% from around 9% over the past few years as it focuses on strengthening its existing operations. Financial engineering in terms of debt-financed share repurchases will continue to be a significant rating consideration for these companies.

Department Stores:
Department stores will be one of the more challenged retail sectors in 2008. Fitch expects companies will continue their focus on presenting differentiated merchandise, including private and exclusive brands, as well as improving store operations through remodels and systems upgrades. Merchandise development cycle time reductions and investments in inventory management systems should also enable stronger operators to respond more effectively to changes in consumer demand. However, heightened promotional activity on weak sell-through merchandise will pressure operating margins, particularly for those retailers with poor inventory controls.

Luxury chains will continue to outperform the rest of the industry, although sales growth will likely moderate due to difficult comparisons following an extended four year period of strong sales gains and as aspirational consumers fall away. However, a weak dollar could continue to drive demand for those retailers, such as Saks and Neiman Marcus, which serve popular tourist destinations. Among mid-tier chains, operators with strong management teams and sharp merchandising strategies, such as Kohl's and J.C. Penney, should be able to solidify or accelerate market share gains, while regional department stores and those with poorly executed strategies are likely to continue to see the weakest top line growth and margin contraction.

Specialty:
Consumer electronics demand will continue to be strong in 2008 relative to other discretionary categories due to incremental sales driven by the digital conversion, the Olympics and further price declines. However, the rate of growth will moderate as much of the new product adoption has already taken place. Operating profit margins will be pressured for those companies with weak inventory and expense management. Competition from discounters will remain intense as they aggressively price and expand their consumer electronics merchandise offerings. Services, such as Best Buy's Geek Squad, will be critical differentiating factors to attract customers due to product complexity and the value of offering total solutions packages.

The following is a list of Fitch-rated issuers and their current Issuer Default Ratings (IDRs) in the U.S. retail sector:

Discounters

--Costco Wholesale Corporation ('AA-'; Outlook Stable);

--Target Corporation ('A+'; Rating Watch Negative);

--Wal-Mart Stores, Inc. ('AA'; Outlook Stable).

Supermarkets and Drug Stores

--CVS Caremark Corp. ('BBB'; Outlook Stable);

--The Kroger Co. ('BBB'; Outlook Stable);

--Rite Aid Corp. ('B-'; Outlook Stable);

--Safeway Inc. ('BBB'; Outlook Stable);

--Supervalu Inc. ('BB-'; Outlook Positive).

Department Stores

--The Bon-Ton Stores, Inc. ('B'; Outlook Stable);

--Dillard's, Inc. ('BB'; Outlook Stable);

--J.C. Penney Company, Inc. ('BBB'; Outlook Positive);

--Kohl's Corporation ('BBB+'; Outlook Stable);

--Macy's, Inc. ('BBB'; Outlook Negative);

--Neiman Marcus, Inc. ('B'; Outlook Stable);

--Nordstrom, Inc. ('A-'; Outlook Positive);

--Saks Incorporated ('B'; Outlook Stable);

--Sears Holdings Corporation ('BB'; Outlook Stable).

Specialty Retail

--Best Buy Co. Inc. ('BBB+' ; Outlook Stable);

--Burlington Coat Factory Warehouse Corp. ('B-'; Outlook Stable);

--The Gap, Inc. ('BB+'; Outlook Negative);

--The Home Depot, Inc. ('BBB+'; Outlook Negative);

--Linens 'n Things, Inc. ('CCC'; Outlook Stable);

--Lowe's Companies, Inc. ('A+'; Outlook Stable);

--RadioShack Corporation ('BB'; Outlook Negative);

--Staples, Inc. ('BBB+'; Outlook Stable);

--Toys 'R' Us, Inc. ('B-'; Outlook Stable).