S&P: Rue21 Inc. 'B-' Rating Affirmed, Outlook Remains Negative On Weakening Competitive Position
"We now view the company's competitive position less favorably, reflecting performance in the increasingly competitive retail apparel market and our expectation that EBITDA margins will remain below 16% for the next few years. Our view of rue21's business risk assessment considers the company's smaller operating scale in the highly competitive and widely fragmented specialty apparel retail sector," said credit analyst Mathew Christy. "Although we believe the company benefits from its primarily off-mall-based store fleet, as mall traffic has generally declined, we also believe the company is not immune to the weakness in the retail apparel industry. We believe the weak trends in the apparel market are a result of more than just cyclical headwinds, rather they are a symptom of secular change in consumer spending habits. Consumers (especially millennials) have increasingly shifted their purchases online, drawn by convenience, selection, and price transparency, which are trends we expect to continue to weigh on rue21's performance."
The negative outlook reflects our expectation that weaker operating performance will result in a decline in EBITDA and slightly negative free operating cash flow, as margins become increasingly pressured from a weak specialty apparel environment. The outlook also incorporates our view that credit metrics will modestly worsen over the next 12 months, including debt to EBITDA in low-7x area for the fiscal year ending January 2017.
A lower rating could result from further deterioration of the company's liquidity such that we do not believe the company will be able to adequately fund its business operations and the capital structure becomes unsustainable. This could occur if a persistent decline in same-store sales at mid-single-digit rate coupled with margins falling more 300 basis points leads to EBITDA declining by more than 15% from our current base-case projection. Under this scenario, adjusted interest coverage would decline below 2.0x and the company would have meaningful and persistent negative free operating cash flow.
We could consider a revision back to stable if the company achieves a sustained improvement in operating performance resulting in positive comparable-store sales growth in the low-single-digit range, operating margin expansion of 100 basis points over our base-case, and positive free operating flow. This scenario would result in EBITDA increasing by more than 8% over our base-case scenario, and adjusted leverage improving to the mid-6x range.