RPT-Fitch Assigns Financiere IKKS S.A.S. (IKKS) Expected IDR of 'B(EXP)'; Outlook Stable
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July 1 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has assigned an expected Issuer Default Rating (IDR) to Financiere IKKS of 'B (EXP)' with a Stable Outlook.
Fitch has also assigned expected ratings to the planned senior secured notes of 'B+/RR3 (EXP)' and super senior RCF of 'BB-/RR2 (EXP)' issued by HoldIKKS S.A.S. The expected IDR of 'B' is a reflection of IKKS's resilient business model given a good mix of distribution channels and a fairly high profitability within the industrial context aided by high variability of costs due to a combination of own and affiliate stores, as well as outsourcing of manufacturing processes. The stability of operations is also underpinned by IKKS' well entrenched position in the premium urban fashion segment, which Fitch view as being less susceptible to macro-economic volatility and less crowded by competing labels.
The ratings are constrained by the limited business scale with FY13 pro forma sales of EUR303.5 million and a pro forma EBITDA of EUR62.3 million, as well as a high initial Funds from Operations (FFO) adjusted leverage of 6.8x based on Fitch's earnings forecast for 2014. Fitch, however, factors in the ratings the expected deleveraging as further expansion would be funded from internal cash flows. A potential corporate governance risk exists due to the commercial relationships with entities directly or indirectly owned by Group Zannier and Roger Zannier. However, Fitch expects that any transactions with related parties will be on an arm's length basis. In addition, Fitch points to the presence of two independent board members.
The ratings will remain expected ratings until the security package is fully put in place, since first-ranking security interest over the issued shares of HoldIKKS S.A.S. will only be provided post completion of the acquisition, with the proceeds from the issue of the notes being placed in an escrow account on the issue date. Failure to issue the above mentioned instruments would result in withdrawal of the instrument ratings and the IDR.
KEY RATING DRIVERS
Moderate Organic Market Growth Forecast
The global apparel market is highly heterogeneous in terms of growth prospects by country. Fitch expects low to moderate growth in developed countries (specifically low single-digit growth in Western Europe) which are IKKS' main addressable markets. The growth is expected to be stronger in some emerging or international markets where IKKS plans to enter.
Expansion and Diversification Drive Growth
Despite low or even contracting development in selected market segments, IKKS has generally shown above-market growth, suggesting an expansion of its market share in a challenging trading environment. The majority of this growth has been driven by new store openings. Retail stores saw a negative Like-for-Like growth of -1.3% in 2013 (compared to 2012) if online-sales are excluded, and +1.2% if online is included. This reflects the importance and complementarity of e-business as a distribution channel.
Business Model Supports Profitability
IKKS has delivered a stable operating profitability at high levels, despite the challenging market environment. The strong and stable margins have been supported by high cost variability given the combination of own and affiliate stores, outsourcing of the manufacturing processes, as well as a growing share of retail channel versus wholesale. As IKKS already operates at the upper end of the profit spectrum relative to close peers, Fitch expects limited upside on its operating margins, considering potential unforeseen costs from its expansion plans.
Growth Strategy with Execution Risk
IKKS intends to expand domestically and abroad, mainly by developing new retail stores and the corner distribution channel whilst operating as a standalone entity within a highly leveraged capital structure. Fitch thinks that the group's strategy is sensible and will likely result in a sustained growth in sales and profits over time. However this strategy bears an execution risk partly offset by the fact that planned capex would be funded by internally generated cash flow from operations (CFO).
Sales Growth to Drive De-Leveraging
With a high starting FFO adjusted leverage of 6.8x IKKS is expected to show a gradual organic de-leveraging to around 5.5x by 2017 led by sales and EBITDA expansion. The group has some cyclicality in its working capital, and Fitch would expect working capital requirements to rise given the envisaged operational expansion. However, should the strategy implementation not lead to expected results, Fitch believes that IKKS has some capex scalability to preserve cash.
Focus on Corporate Governance
IKKS is being sold by Group Zannier (which was founded by Roger Zannier and is today controlled by his children). Group Zannier intends to use the proceeds to repay its long-term debt. Fitch expects that IKKS will maintain certain commercial relationships with its former parent and companies in which Mr. Roger Zannier has a direct or indirect interest, including but not limited to logistics and IT services. Fitch expects that these transactions will be conducted on an arm's length basis.
Fitch expects that the shareholder contribution (ca 36% of acquisition value) will consist of up to one third of shareholder loans being structurally and contractually subordinated to the RCF and senior secured notes, bear an all-PIK interest, have a longer maturity, contain no financial covenants, no event of default, no cross-default; however it will feature a cross-acceleration clause. In line with its treatment of shareholder loans, Fitch excludes this instrument from its leverage calculation.
Above Average Recoveries
The recovery rates for the debt instruments are based on Fitch's post-restructuring going concern estimate. Fitch has used a pro forma adjusted 2013A EBITDA of EUR63.4 million as a basis and applied a discount of 25%. A hypothetical future distressed valuation could be underpinned by additional business growth although Fitch notes that the business will remain largely asset-light as IKKS uses primarily rented retail space and outsources manufacturing and supporting business service processes.
After applying a distressed EV/EBITDA multiple of 5.0x and customary
restructuring charges, the expected rating and recovery for the Super Senior RCF would be in the 'BB-/RR2 (EXP)' category (71%-90%) capped by the French jurisdiction. The rating and recovery for the planned EUR320 million notes secured by share pledge over Financiere IKKS would fall in the 'B+/RR3 (EXP)' category (51%-70%) being one notch higher than the IDR.
A rating upgrade or revision of the Outlook to Positive is unlikely in the short to medium term given the group's highly leveraged capital structure and the execution risk embedded in the future growth strategy.
For any positive rating action to be considered Fitch would need evidence that the expansion is implemented successfully. The following would provide support for this:
--FFO adjusted leverage sustainably below 5.0x
--FFO fixed charge cover above 2.2x on a sustainable basis
--FCF margin (after capex) sustainably above 5%
--EBITDA of at least EUR80m in combination with a successful business plan implementation leading to evidence of resilient profit margins The IDR could be downgraded or the outlook changed to negative if:
--IKKS fails to de-lever to below 6.5x on FFO adjusted leverage basis by the end of 2015 or is expected to remain at around such level on a forward-looking basis
--FFO fixed charge cover ratios sustainably below 1.8x
--EBITDA deteriorates sustainably below 20%
--Signs of adverse impact resulting from corporate governance issues
LIQUIDITY AND DEBT STRUCTURE
Sufficient Liquidity Expected: Fitch expects the Group to consistently generate positive Free Cash Flow (FCF), with the possibility to adjust its capex based on business conditions, and maintain adequate FFO fixed charge cover of around 2.0x. The available EUR40 million revolving credit facility (RCF) provides additional headroom for liquidity.
The EUR 320 million notes are expected to be subject to an incurrence covenant based on a fixed charge cover of 2x. The super-senior RCF has a leverage based maintenance covenant, although this only becomes effective if the utilization of the RCF exceeds EUR25 million. Moreover, in case of non-compliance the issuer has equity cure options.