OREANDA-NEWS. Senior debt recovery expectations for leveraged European non-food retailers have fallen significantly and are likely to stagnate at best in the medium term due to difficult trading conditions, a high fixed-cost base and lack of deleveraging, Fitch Ratings says. However, recovery expectations for performing loans are likely to remain higher than for similarly leveraged borrowers in other sectors.

A review of Fitch's portfolio of around 400 European credit opinions shows that recovery expectations for high-yield non-food retailers are marginally below 70%, or roughly three percentage points higher than the average for the entire portfolio. This is down from a peak of 83% in mid-2014, when the gap was around 13 percentage points.

The sharp decline in recovery expectations for the sector has tracked the increasingly aggressive senior debt structures since the start of 2015 as retailers have refinanced and recapitalised in debtor-friendly credit markets. It also reflects the impact of disruptive competition and a challenging environment of subdued economic growth, uneven consumer confidence and high unemployment in some continental European markets.

We believe the combination of aggressively funded balance sheets with challenged commercial profiles and low organic growth prospects will make deleveraging difficult in the medium term. This suggests recovery rates for senior debt are likely to remain flat or deteriorate further.

However, European non-food retailers have historically had higher recovery expectations than any sector other than telecoms, and we expect recoveries to remain relatively strong for performing retail leveraged loans and high yield despite the numerous sector challenges.

There are several factors that help drive this trend, including slim operating and free cash-flow (FCF) margins, which are generally between 1% and 3% for retailers in the 'B' rating category, compared to mid- to high single digits for similarly rated companies in other sectors. This means retailers already operate close to the level of financial stress and the EBITDA discounts used to calculate a hypothetical point of distress as a proxy for going-concern restructuring are therefore smaller than for other sectors.

The other main factor is the enterprise value (EV) to EBITDA multiple that we use to estimate a potential sale price for the business. The vast majority of non-food retailers attract a distressed EV/EBITDA multiple of 5.0x and unlike many other sectors this multiple tends not to decline as a credit migrates down the rating scale. This has limited the drop in expected recoveries even as an accelerated downward trend in ratings has driven credit profiles in the sector to their weakest level since 2010.