S&P: Payless Inc. Outlook Revised To Negative On Weakened Operating Performance; 'B' Rating Affirmed
We also are affirming the 'B' issue-level rating on the company's first-lien term loan and revising the recovery rating to '4' from '3'. The '4' recovery rating reflects our expectations for average recovery in the event of default at the low end of the 30% to 50% range. We affirmed the 'CCC+' issue-level rating on the second-lien term loan and the recovery rating remains '6', reflecting our expectation for negligible (0% to 10%) recovery.
"The outlook revision reflects the company's meaningful underperformance over the past 12 months, and our expectation that operating performance will continue to be soft over the next 12 months as the company continues to struggle to drive traffic into its stores," said credit analyst Andrew Bove. "Merchandising and inventory management at Payless have been largely ineffective, which has resulted in increased promotional activity and decreased customer traffic. In addition, the value shoe category has become increasingly competitive in recent years, and we believe that off-price competitors like TJX and DSW have taken some market share from Payless over that time period. We expect adequate availability under the company's revolving credit facility to fund seasonal working capital needs. However, company profitability has historically been volatile, and further underperformance below our base-case forecast could result limited access to the revolver and a tightened liquidity position."
The negative outlook on Payless reflects our belief that despite our expectation for some moderation in recent negative trends, operating performance will continue to be soft over the next 12 months. We expect that profitability and cash flow will be pressured over that time period as the company recovers from the inventory and merchandising issues experienced over the past year, but still faces difficult store traffic because of increased competition. We are forecasting debt-to-EBITDA in the mid-4.0x for year-end January 2017 but liquidity to remain adequate over the next 12 months.
We could lower the ratings if comparable-store sales remain negative over the next 12 months, and the company is unable to improve profitability over that time period. Under this scenario, same-store sales would decrease in the low - to mid-single digits and margins would contract 75 bps, resulting in meaningfully negative free operating cash flow. This decline in performance would result in EBITDA continuing to contract, leading to leverage approaching 5.0x and fixed-charge coverage in the low-1.0x area. This would also result in further tightening of availability under the revolving credit facility, potentially limiting the company's liquidity position.
Although unlikely in the next 12 months, we could revise the outlook back to stable if the company demonstrates improved and consistent performance with same-store sales gains in the low - to mid-single digits, along with meaningful margin expansion of about 100 bps. This could happen if management can execute a more focused merchandise strategy that resonates well with consumers, and can manage its inventory effectively to meet demand and limit promotional activity. Under this scenario, EBITDA would grow around 15%, resulting in leverage in the low-4.0x area and fixed-charge coverage in the mid-1.0x range.