October 16, 2012 / 4:30 PM / 5 years ago

TEXT-S&P cuts Quiksilver to 'B-'

Overview
     -- U.S.-based Quiksilver's credit metrics have weakened and liquidity has 
become constrained from declining profitability amid a highly promotional 
retail environment.
     -- We are lowering our corporate credit rating on the company to 'B-' 
from 'B'.
     -- We are also lowering the issue-level ratings on the company's EUR200 
million European senior unsecured debt to 'B-' from 'B', and the rating on its 
$400 million senior unsecured debt to 'CCC' from 'CCC+'. The recovery ratings 
are '4' and '6', respectively. 
     -- The outlook is negative, reflecting our view that weaker operating 
performance could continue over the next year, and our view that the company 
has less than adequate liquidity.  

Rating Action
On Oct. 16, 2012, Standard & Poor's Ratings Services lowered its corporate 
credit rating on Huntington Beach, Calif.-based Quiksilver Inc. to 'B-'
from 'B'. The outlook is negative. 

At the same time, we lowered our issue-level rating on Quiksilver's EUR200 
million European senior unsecured debt to 'B-' from 'B'. We also revised the 
recovery rating on this debt to '4', indicating our expectation of average 
(30% to 50%) recovery for noteholders in the event of a payment default, from 
'3'.

In addition, we also lowered our issue-level rating on the company's $400 
million senior unsecured debt to 'CCC' from 'CCC+', with a '6' recovery 
rating, which indicates our expectation of negligible (0% to 10%) recovery in 
the event of a default.

Rationale
Today's rating actions reflect our view that Quiksilver's profitability has 
materially declined, liquidity has become constrained, and covenant cushion 
has tightened to below 10%. Given the tight covenant cushion, we have revised 
the company's liquidity descriptor to "less than adequate" from "adequate." We 
believe the company's operating performance could continue to be pressured by 
headwinds from unfavorable foreign currency exchange, weak macroeconomic 
conditions (particularly in certain European countries where youth 
unemployment is high), and a highly promotional retail environment. We 
forecast covenant tests could potentially be breached when the interest 
coverage steps up next quarter. 

The ratings on Quiksilver reflect our view that the company has a "highly 
leveraged" financial risk profile based on its weakening credit metrics and 
less than adequate liquidity. We also continue to characterize the business 
risk profile as "vulnerable" because of its exposure to the cyclical apparel 
industry, its relatively narrow niche focus in the competitive apparel 
industry, and the fashion risk inherent in its target market.

We estimate adjusted total debt to EBITDA is high at 5.8x for the 12 months 
ended July 31, 2012, compared with 4.7x in the prior-year period, due mainly 
to lower profitability from higher input costs and promotional activity. The 
ratio of funds from operations (FFO) to total debt was 12.6% and EBITDA 
interest coverage was 2.2x, compared to 18.3% and 1.7x, respectively, in the 
prior year. We expect credit measures will remain near current levels, 
including adjusted leverage in the low-6x area at fiscal year ending October 
2012 and high-5x area in fiscal 2013. We also project break-even free cash 
flow in fiscal 2013 (due to lower working capital requirements as cotton costs 
decline) compared with negative free operating cash flow in fiscal 2012 (from 
higher input costs and capital expenditures). We expect credit metrics to 
remain commensurate with the indicative ratios for the "highly leveraged" 
financial risk descriptor, which includes adjusted leverage above 5x, over the 
next year.

Our forecast includes still-difficult economic conditions, including weak 
economic growth, high unemployment, and weak consumer spending through 2013. 
Our operating performance assumptions for the company over the next year 
include:

     -- Low-single-digit sales growth, given the economic weakness, 
particularly in Europe, offsetting our expectation of positive revenue growth 
in the Americas.
     -- EBITDA margins remaining pressured and below 10%. The margin decline 
primarily reflects higher promotional activity and input costs. The company 
may begin to benefit somewhat from lower cotton costs in the second half of 
the year but we do not expect EBITDA margins to recover to historical 13%-14% 
levels.
     -- Capital expenditures of about $75 million. 
     -- No debt-financed acquisitions, dividends, or share repurchases. 
     -- No debt prepayments, other than required annual amortization. 

The company maintains a portfolio of well-known niche brands, such as 
Quiksilver, Roxy, and DC Shoes. In our view, the brand portfolio continues to 
be narrowly focused in young men's and women's surfboard- and 
skateboard-related apparel and accessories. Fashion risk in this segment is 
especially high as customer tastes tend to change frequently, which could lead 
to excess inventories and promotional activity, and has in the past resulted 
in inconsistent operating performance.

Liquidity
We assess Quiksilver's liquidity as less than adequate. Though sources of cash 
are likely to exceed cash uses for the next 12 months, we believe covenant 
cushion could remain below our 15% threshold for "adequate" liquidity. Cash 
sources include about $82 million of cash on hand, about $117 million of 
availability on its committed $150 million Americas asset-based revolver ($62 
million outstanding) due 2014, and about $91 million of uncommitted European 
and Asia-Pacific lines of credit at July 31, 2012. We also expect the company 
to generate about $145 million of adjusted funds from operations over the next 
year. We expect cash uses to include capital spending of about $75 million and 
relatively modest debt amortization of about $3 million. The company does not 
pay a dividend and we did not factor in any acquisitions or share repurchases.

Our assessment of Quiksilver's liquidity profile also includes the following:
     -- We expect coverage of uses to be in excess of 1.2x for the next 12 
months.
     -- The only maintenance financial covenant is a minimum interest coverage 
test for the company's Americas term loan, of which covenant cushion decreased 
to under 10% in the recent July quarter. There is a covenant step-up in the 
October quarter and we assess that covenant tests could be breached if EBITDA 
(as calculated per the credit agreement) does not materially increase to 
satisfy the covenant step up in the October quarter. There is about $26 
million outstanding on the Americas term loan as of July 31, 2012. The 
covenant resets after each fiscal year.
     -- We do not believe the company would be able to absorb high-impact, low 
probability stress events.

Recovery analysis
The rating on the EUR200 million European senior unsecured debt issue held at 
subsidiary Boardriders SA is 'B-' (the same as the corporate credit rating on 
Quiksilver), and the recovery rating is '4', indicating our expectation that 
lenders would receive average (30% to 50%) recovery in the event of a payment 
default. The rating on the $400 million senior unsecured debt issue is 'CCC' 
(two notches lower than the corporate credit rating), and the recovery rating 
is '6', indicating our expectation that lenders would receive negligible (0% 
to 10%) recovery in the event of a payment default. For the complete recovery 
analysis, see Standard & Poor's recovery report on Quiksilver Inc. to be 
published shortly on RatingsDirect.

Outlook
The rating outlook is negative, reflecting our expectation that Quiksilver's 
operating performance could continue to be pressured by foreign currency 
exchange rates, weak macroeconomic conditions, and a highly promotional retail 
environment. We believe liquidity will continue to be constrained and less 
than adequate, given the company's interest coverage covenant could 
potentially be breached.

We could revise the outlook to stable if the company is able to improve 
profitability or if lenders provide covenant relief, leading to forecasted 
covenant cushion sustained above 10%. We estimate this could occur if EBITDA 
(as defined per the credit agreement) increases 58% next quarter, which is 
unlikely. Because covenant levels reset annually, it is difficult to estimate 
covenant cushion in fiscal 2013 at this time. 

Alternatively, we could lower the ratings if liquidity becomes further 
constrained, perhaps from a material sales decline (possibly because of 
changes in consumer tastes, a weak back-to-school season, or the soft global 
economy), and/or if the company is unable to amend or obtain a waiver on its 
Americas credit agreement, defaults on its credit facility, and cross-defaults 
on its other debt.  

Related Criteria And Research
     -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
     -- Methodology and Assumptions: Liquidity Descriptors For Global 
Corporate Issuers, Sept. 28, 2011
     -- Key Credit Factors: Criteria For Rating The Global Branded Nondurable 
Consumer Products Industry, April 28, 2011
     -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009

Ratings List
Downgraded; Outlook Action
                                        To                 From
Quiksilver Inc.
 Corporate Credit Rating                B-/Negative/--     B/Stable/--
 Senior Unsecured                       CCC                CCC+
  Recovery Rating                       6                  6

Boardriders SA
 Senior Unsecured                       B-                 B
  Recovery Rating                       4                  3



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.

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