December 21, 2017 / 4:57 PM / 3 months ago

Fitch Places IKKS' Ratings on Rating Watch Negative

(The following statement was released by the rating agency) FRANKFURT/LONDON/PARIS, December 21 (Fitch) Fitch Ratings has placed on Rating Watch Negative (RWN) the Long-Term Issuer Default Rating (IDR) of Financiere IKKS S.A.S. of 'CCC'. Fitch has also placed on RWN the super senior revolving credit facility (RCF) of 'B-'/ 'RR2'/90% issued by IKKS Group S.A.S and the senior secured notes of 'CCC'/'RR4'/50% issued by HoldIKKS S.A.S. The RWN reflects an increased risk of a payment default on the senior secured notes in 2018, with the company exhibiting limited headroom to pay approximately EUR11 million in cash in mid-January 2018, and its unclear liquidity situation afterwards given its weaker cash-flow generation and fully exhausted committed debt funding. Fitch will resolve its RWN once it has a clearer view of the sources of funds available for the mid-January coupon payment, and of IKKS's liquidity over the next 12 months, together with an expectation of operational stabilisation. Although currently not factored in, a weak liquidity profile could be eased by an equity injection from the sponsor, and/or renegotiation of the RCF on favourable terms. KEY RATING DRIVERS Coupon Payment at Risk: Fitch sees an increased risk of coupon non-payment on the senior secured notes in 2018, given limited committed funding under the RCF and a large portion of uncommitted debt facilities. Evidence of easing liquidity pressures coming from strong Christmas sales and/or near-term additional external liquidity sources could support a removal of the RWN in 1H18. Risk of Covenant Breach: High reliance on external funding in combination with weak trading is likely to lead to a covenant breach under the RCF as of end- December 2017. A waiver or renegotiation of an already relaxed covenant only a year ago may be less easy to achieve with the RCF lenders this time. The terms on which the lenders, the sponsor and the company will engage in the next covenant negotiation remain unclear. We also note the need for a covenant reset for 2018, and possibly also for 2019, in order to minimise the risk of repeat covenant breaches in the next 12-24 months. Unclear Prospects for Operational Turnaround: We expect no improvement in sales and EBITDA at fiscal year-end 2017 over 2016 based on uneven performance in the first three quarters of the year and no clear positive customer feedback on the new fall/winter collection for 2017/18. We anticipate, however, some trading consolidation with the contribution of the new chief designer, whose impact on the success of the next collection will become visible in 2018. We also base our Fitch case projections on the expectation of remedial action by the management to halt the negative operating trend. Operating Profitability to Remain Low: EBITDA margin is expected to remain at historically low levels of 11%-12%, held back by a higher share of older collections after the addition of the Outlet business in early 2017 and slow reconnection with the customer base after the rather unsuccessful collections launched in FY16-17. Negative Free Cash Flow: Weak funds from operations (FFO) in combination with a scaled back level of capex estimated at EUR15 million in 2017, will result in persistently negative free cash flows (FCF), requiring a continuous reliance on external funding. Trade working capital outflow of EUR21 million (including the adjustment for factoring of EUR3 million) projected for FY17, which is impacted by inventory left-overs from 2016 and the addition of the Outlet business will materially affect the FCF profile. From 2018, we anticipate the volatility in trade working capital subside after it adjusts to the new enlarged distribution platform. Unsustainable Leverage: Since the collapse in EBITDA in 2016 the debt structure with an FFO adjusted leverage of 9-10x has become unsustainable, implying a 'CCC' type of financial risk. In the absence of a marked operating turnaround or a reduction of the debt amounts, we see no room for a medium-term improvement back to the performing levels of under 7.0x on FFO adjusted level. Debt Instruments on RWN: Concurrently with the placement of the IDR on RWN, we have placed IKKS' super senior RCF and senior secured notes on RWN, indicating expectations of potentially reduced recoveries in the event of default resulting from more permanent brand erosion, and a possibility of a downgrade at the time of the resolution of the Rating Watch. DERIVATION SUMMARY Similarly to other European clothing retailers of the same credit quality such as New Look Retail Group Retail Group Ltd (CCC) or Novartex S.A.S. (CCC), IKKS has been struggling operationally, which is reflected in declining sales, EBITDA and FFO margins, and excessive financial leverage at about 9.0x adjusted FFO. The reasons for operating underperformance for all three companies ultimately lie in the structural changes in non-food retail, with uncompetitive offerings eroding the customer base, even in the more conservative, and therefore traditionally more stable, premium clothing segment. The rating of 'CCC' for all three issuers also incorporates uncertainties over a near-term, trading restoration and marked improvement in internal cash-flow generation. High execution risks in the evolving business models lead to sustainably excessive leverage levels and heightened liquidity risks. KEY ASSUMPTIONS Fitch's Key Assumptions Within Our Rating Case for the Issuer: - no sales growth in FY17, thereafter low single digit growth rates; - EBITDA margins at 11%-12% (creation costs of EUR 5-6 million are included); - capex scaled back to EUR 15million a year (creation costs of EUR 5-6 million are excluded); - trade working-capital outflow of EUR 21 million in FY17, neutral thereafter. Recovery Analysis: After having been placed on RWN, the instrument recovery ratings remain unchanged from our previous rating action in April 2017. The recovery analysis is based on the going-concern approach given IKKS's asset-light business model. As a starting point we use our estimate for a post-distress EBITDA of EUR43 million (including creation costs of around EUR 5.5million) with a 0% discount, serving as a cash-flow proxy post distress, at which level IKKS would operate around break-even on the FCF level. By making reference to Fitch's rated non-food retailers such as Novartex S.A.S. (CCC) and New Look Retail Group Ltd. (CCC) as well as other non-public peers in Fitch's sector coverage, we apply a distressed EV/EBITDA multiple of 5.0x, which reflects the still intact brand equity, the quality of the store network, as well as its multiple store formats and distribution channels. After deducting the customary administrative charges of 10%, we estimate the lenders of the super senior RCF would recover in a hypothetical distress situation up to 90% of the claims, capped by the French jurisdiction in accordance with Fitch's country-specific treatment of recovery ratings. This would lead to an RCF instrument rating of 'B-'/RR2/90%, with a two-notch uplift from the IDR. After considering super senior creditors claims, we estimate that holders of the senior secured notes, which rank second on enforcement, are estimated to recover up to 50% of the claims, leading to an instrument rating of 'CCC'/ 'RR4'/50%. Fitch will reassess the recovery ratings at the time of resolution of the RWN. RATING SENSITIVITIES Developments that May, Individually or Collectively, Lead to a Removal of RWN: - evidence of sufficient cash to make a timely coupon payment of EUR11 million on 15 January 2018 with expectation of a stabilising operating performance and liquidity remaining tight, but sufficient to accommodate contractual debt service in the medium term; - waiver or reset of the financial maintenance covenant under the RCF eliminating the risk of a breach in the next 12-24 months. Developments that May, Individually or Collectively, Lead to Negative Rating Action - Lack of evidence that IKKS is able to pay its coupon of EUR11 million on 15 January 2018 on time, no signs of operating stabilisation and further liquidity erosion undermining the company's ability to service its debt obligations in the next 12-24 months - Risk of a financial covenant breach under the RCF remaining in the next 12-24 months. LIQUIDITY Poor Internal Liquidity, Reliance on Debt: Based on our expectations of flat sales for 2017 compared with 2016, particularly assuming Christmas sales will not deviate much from the prior year, we project IKKS will generate EUR15 million in negative FCF, which would have to be fully funded by debt. We also forecast the RCF will remain fully drawn over the next four years in order to close internal funding gaps. In the absence of further committed bank loans, IKKS will be operating under a very tight liquidity scenario with access to uncommitted funding, which can be easily cancelled and is therefore considered as less reliable. We further include the utilisation of receivables factoring of EUR3 million in FY17, followed by a further increase of EUR2 million thereafter. This is reflected in accordance with Fitch's treatment of receivables factoring. Contact: Principal Analyst Sophie Coutaux Senior Director +33 1 44 299 132 Supervisory Analyst Elena Stock Director +49 69 76 80 76 135 Fitch Deutschland GmbH Neue Mainzer Strasse 46-50 D-60311 Frankfurt am Main Committee Chairperson Edward Eyerman Managing Director +44 203 530 1359 Summary of Financial Statement Adjustments: - operating leases are capitalised using a multiple of 8.0x and added to financial debt; - EUR 15 million is treated as restricted cash required for operations; - shareholder loan is treated as 100% equity; - creation costs of EUR5.5 million are included in EBITDA and excluded from capex; - senior secured notes are adjusted to face value; - receivables factoring is adjusted by increasing the inventories and financial debt by EUR3 million in FY17 and further EUR2 million thereafter. Media Relations: Adrian Simpson, London, Tel: +44 203 530 1010, Email: Additional information is available on For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. Applicable Criteria Corporate Rating Criteria (pub. 07 Aug 2017) here Country-Specific Treatment of Recovery Ratings (pub. 18 Oct 2016) here Exposure Draft: Corporate Rating Criteria (pub. 14 Dec 2017) here Exposure Draft: Sector Navigators (pub. 14 Dec 2017) here Non-Financial Corporates Notching and Recovery Ratings Criteria (pub. 16 Jun 2017) here Additional Disclosures Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. 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