OREANDA-NEWS. S&P Global Ratings today lowered its corporate credit rating on the Pittsburgh, Pa.-based vitamin and supplement retailer GNC Holdings Inc. to 'BB' from 'BB+'. The rating outlook is negative.

At the same time, we lowered our issue-level rating on the company's senior secured term loan facility to 'BB+' from 'BBB-'. The '2' recovery rating is unchanged, reflecting our expectation for substantial recovery (70%- 90%, lower half of the range) of principal in the event of a payment default or bankruptcy.

"The downgrade reflects our view that the company's weak operating performance will remain amid increased competition (especially from online and mass merchant retailers), poor execution of its pricing and merchandising strategies, and meaningful contraction in operating margin and store productivity, resulting in a less favorable assessment of the company's competitive positioning and operating efficiency," said credit analyst Mathew Christy. "We had expected sequential improvement in same-store sales, but the negative sales trend accelerated in the second quarter, as falling customer traffic led to a 3.7% decline in comparable sales, up from the same-store sales decline of 2% in the first quarter. Although the company is attempting to address comparative product pricing through changes in promotions, we think the weakness in the customer traffic trends will likely persist for the remainder of 2016, leading to a 5% sales decline for the yearin our forecast. EBITDA margins contracted by more 200 basis points (bps) in the second quarter because of sales deleveraging and falling product margins, worse than our expectations for a 100-bp decline. We see the accelerated negative performance as a result of the heightened competitive landscape, and believe meaningful traffic headwinds and competitive pressures have more than offset the company's various operating initiatives. As a result, we are revising our assessment of GNC's business risk to fair from satisfactory."

The negative rating outlook reflects our expectation that weak operating trends will persist over the next 12 to 18 months, with lower comparable sales reflecting shifting promotional strategies and increased discounting, increased competition from online and mass merchant vendors, and sustaining lower customer traffic. In addition, the outlook considers the risks from the recent abrupt change of CEO and the ongoing strategic review. We also forecast debt leverage in the mid-3x area in 2016 and FFO to debt of about 20% in 2016.

We could lower our ratings if operating performance is worse than our base-case projections and free operating cash flow generation is weaker than we expect, leading to slower debt leverage reduction. Under such a scenario, the decline in sales would accelerate to the mid - to high-single-digit range and margins would continue to decline more than 250 bps, as the magnitude of the customer traffic loss increases. In this case, FFO to debt would remain at or below 20% and debt leverage would remain at or above the mid-3x range. We could also lower the rating if the company adopts a more aggressive financial policy as a result of its strategic initiative review, leading to similar credit metrics as per above.

While not likely given the company's performance trend and its current strategic review, we could revise the outlook back to stable if we believe the company's ongoing operating initiatives or reinvigorated operating results from new management lead to improved performance on a sustained basis, such that same-store sales trends improve and pricing initiatives lead to better profit margins. This will also result in strengthened free operating cash flow generation prospects, and improved credit metrics such that leverage sustains below 3x and FFO-to-debt is around the mid 20% range. In addition, we must also believe the improved credit metrics are supported by the company's financial policy as concluded by its strategic review.