TEXT-S&P cuts Gymboree Corp.'s rating to 'B-'
Overview -- U.S. children apparel retailer Gymboree's profitability gains will be limited despite easing cotton prices, and we expect debt leverage to remain above 7x in the next 12 months. -- We are lowering the company's ratings, including the corporate credit rating to 'B-' from 'B'. -- The ratings outlook is stable based on adequate liquidity and modest improvement in operating margins. Rating Action On Nov. 9, 2012, Standard & Poor's Ratings Services lowered its corporate credit rating on San Francisco-based children's apparel retailer The Gymboree Corp. To 'B-' from 'B'. The outlook is stable. At the same time, we lowered our issue-level rating on the company's $820 million senior secured term loan to 'B-' from 'B' and left the existing '3' recovery rating unchanged. We also lowered the issue-level rating on Gymboree's $400 million senior unsecured notes to 'CCC' from 'CCC+' and left the '6' recovery rating unchanged. Rationale The rating on Gymboree continues to reflect our view of the company's "weak" business risk profile and "highly leveraged" financial risk profile. We do not expect these assessments to change over the next 12 months. The weak business risk profile reflects Gymboree's participation in the very competitive and fragmented children apparel industry, its vulnerability to cotton price inflation, and susceptibility to fashion missteps. Over the past six quarters, Gymboree's EBITDA margin fell almost 800 basis points to about 16.4% on July 28, 2012, as a result of high markdowns related to divergence from its product styling, and high cotton prices that hurt gross margin over the past four quarters. Although cotton prices have declined significantly from peak levels in 2011, we believe the company's margins will likely only modestly improve over the next 12 months. Sluggish economic recovery will continue to strain consumers discretionary spending in our view, and Gymboree will likely remain highly promotional to propel traffic to its stores. In addition, recent management changes following the departure of the CEO and unsuccessful efforts to fill the CFO position could result in a lack of direction for the company and cause another deviation from known product styling. Our specific assumptions for the company's performance over the next 12 months include the following assumptions: -- Mid-single-digit percent revenue growth because of flat to modestly positive same-store sales growth and incremental sales from new stores. -- EBITDA margin improving to slightly over 17% from the current 16.4% because of benefits of lower cotton prices, offset by promotional activities and growth of the lower-margin Crazy 8 concept. -- Capital spending of about $45 million and positive free operating cash flows (FOCF) of more than $30 million in 2012. We view Gymboree's financial risk profile as "highly leveraged." Although we anticipate modest margins improvement and small EBITDA gains over the next couple of quarters, we believe the company will remain highly leveraged, with total debt to EBITDA exceeding 7x in the next 12 months. EBITDA coverage of interest will also remain weak at below 2x and funds from operations to total debt will be thin at only about 9%. Liquidity Liquidity is "adequate" for the company. We believe that cash on hand of $54.6million, funds from operations, and about $177 million available under the company's $225 million ABL revolver are sufficient to cover cash needs for the next 12 to 18 months. We anticipate Gymboree will generate positive FOCF during 2012, despite higher capital spending to support aggressive store expansion. Relevant aspects of the company's liquidity, in our view, are as follows: -- We expect the company's sources of liquidity (including cash and unused revolving credit facility capacity) to exceed its uses by 1.2x or more over the next 12 months. -- We also expect net sources to be positive, even if EBITDA drops 15% over the next 12 months. -- We expect the company to remain compliant with its financial fixed-charge coverage covenant, which applies if excess availability under the revolver is less than 12.5% of the borrowing base or $20 million. -- The company appears to have a sound relationship with its banks. -- Gymboree has minimal debt maturities over the next 12 months. Recovery analysis Standard & Poor's rates Gymboree's $820 million senior secured term loan 'B-' with a recovery rating of '3'. This indicates our expectation of meaningful (50% to 70%) recovery in the event of a payment default. The rating on the company's $400 million senior unsecured notes is 'CCC'. The '6' recovery rating on this debt indicates negligible (0% to 10%) recovery in the event of a payment default. Outlook Our outlook on Gymboree is stable. Despite our anticipation for modestly improving margins, we believe that the sluggish economic recovery and increasing competition will continue to strain profitability over the next 12 months, hindering meaningful improvement of the company's credit measures. Still, we expect the company to maintain adequate liquidity. We could downgrade the company if operating challenges pressure Gymboree's free operating cash flow generation, eroding its liquidity. An upgrade is unlikely in the next 12 months, given our expectation that credit metrics will not improve sufficiently in the face of operational challenges. However, we could raise the rating if total debt to EBITDA improves toward 6x and coverage of interest increases to more than 2x. Related Criteria And Research -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Ratings Lowered To From The Gymboree Corp. Corporate Credit Rating B-/Stable/-- B/Stable/-- Senior Secured B- B Recovery Rating 3 3 Senior Unsecured CCC CCC+ Recovery Rating 6 6 Temporary telephone contact numbers: Mariola Borysiak (973-518-0389); Jayne Ross (973-735-3761). Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.