June 20 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has assigned New Look Retail Group Limited's (New Look; 'B-'/Stable) GBP808m senior secured notes issued by New Look Bondco I plc a final 'B' rating with a Recovery Rating of 'RR3'. The rating action follows the review of final terms of the bond issue principally conforming to information already received by Fitch.
As expected, the proceeds have been used to repay all indebtedness under the previous senior facilities agreement and mezzanine facility agreement, in addition to funding the cash tender of approximately half of the previously outstanding PIK loans. In conjunction with the tender offer, New Look will exchange the remaining PIK liabilities for a new PIK loan facility issued through a special purpose vehicle located within the restricted group that matures in November 2018. The new notes rank as senior secured obligations and benefit from guarantees from certain operating subsidiaries representing over 97% of the restricted group's adjusted EBITDA.
New Look's 'B-' IDR reflects the aggressiveness of the proposed recapitalisation. However, this is offset by its established market leadership in the UK, favourable medium-term industry trends and improving operating performance in recent quarters. From a business risk standpoint, Fitch views New Look as possessing a number of company-specific traits consistent with a higher rating. However, the company's financial profile and limited expected de-leveraging potential, are more in line with a low-rated 'B' issuer and are viewed as constraining factors for New Look's ratings.
Established Market Position
Fitch considers New Look's high fashion content and value proposition as differentiating factors compared with its immediate peer group. This has resulted in a strong brand position in the UK value clothing segment, which is benefiting from a long-term structural change, largely driven by increased acceptance of value retail brands. New Look is further supported by the multi-channel offering comprising over 1,100 owned and franchised stores worldwide (590 owned stores in the UK) and a fast-growing e-commerce and mobile-commerce presence. These company-specific traits justify a high 'B'/low 'BB' rating category but the rating is constrained by the company's reliance on the UK market.
New Look aims to improve EBITDA back to the previous highs of FY10. However, the mix of EBITDA is fundamentally different with the share of UK retail profit expected to contribute a lower percentage of overall group EBITDA in the coming years with the e-commerce division generating an increasing percentage of growth in group EBITDA from FY13. Fitch views management's growth assumption as reasonable based on current trends and results achieved in recent periods. More broadly, these expectations are consistent with industry trends as online retailing is expected to grow at 15.1% (CAGR) from 2012 to 2016.
Subdued UK Consumer Environment
Although New Look plans to increase its overseas exposure, its UK division remains a major part of its business, contributing 78% of group revenue and 93% of group underlying operating profit in FY13. The UK consumer environment remains subdued as unemployment is still high, household incomes remain squeezed and the real wage continues to fall. As a result, competition among clothing retailers is very high with promotions and discounting being the new norm in the industry.
Improving Operating Performance
Despite the strong brand franchise, operating performance in recent years has been affected by several factors, both internal and external. This includes a one-off event with the departure of 40% of its key buyers when New Look moved its headquarters from Weymouth to London. As a result, there was inconsistent ranging, pricing and quality in its products, which led to increased markdowns and depressed profitability in FY11 and FY12. The poor operating performance has since reversed, as evidenced by a 29% year-on-year improvement in reported adjusted EBITDA in FY13. Fitch expects the UK retail sector to remain under pressure driven by weak consumer confidence and above-average supply chain inflation. In FY13, New Look reported sales increased by 2.5% (FY12: -0.9%) and EBITDA margin improved to 12.7% (FY12: 9.6%). Further gradual improvement in profitability is factored in thereafter.
Aggressive Financial Profile
Fitch characterises New Look's financial profile as aggressive. This is prompted by the partial refinancing of the old Holdco PIK loan with additional debt issued at the same restricted group as the issued senior secured notes, which justifies the 'B-' IDR despite the extended debt maturity profile. In addition, Fitch has included the new PIK facility in its calculation of leverage metrics. Several characteristics that support this approach include guarantees from operating subsidiaries within the restricted group, option to pay interest in cash and transferability of rights and obligations. Fitch projects FFO-adjusted net leverage to increase to around 7.1x (cash-pay FFO-adjusted net leverage of 6.0x) by FYE14 (March 2014). In Fitch's definition of FFO-adjusted net leverage (including PIK), this is weak relative to the 'B' median for the sector at 6.0x. FFO fixed charge cover (including cash interest and rents) is equally considered weak at 1.5x.
Senior Secured Notes' Rating
The 'B'/'RR3' senior secured rating reflects Fitch's expectations that the enterprise value of the company - and resulting recovery for its creditors - will be maximised in a restructuring (going concern approach) rather than a liquidation due to the relatively asset-light nature of the business.
Furthermore, a default scenario would likely be triggered by unsustainable financial leverage, possibly as a result of increasingly weak consumer spending or poor acceptance of the company's product roll-outs. As such, Fitch has applied a 25% discount to FY13 EBITDA and believes a distressed multiple of 5.0x is appropriate. This results in above-average expected recoveries (51%-70%) for senior secured noteholders in the event of default.
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
- FFO-adjusted net leverage (including PIK) consistently below and expected to be sustained below 6.5x
- FFO fixed charge cover (including cash interest and rents) consistently above 1.7x - 2.0x
- EBITDA margins at or above 15% driven by core business improvement
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
- FFO-adjusted net leverage (including PIK) consistently above 8.5x
- FFO fixed charge cover (including cash interest and rents) consistently below 1.2x
- EBITDA margins below 10%
- Inability to maintain positive free cash flow delaying deleveraging potential