April 7, 2017 / 3:59 PM / in 7 months

Fitch Downgrades IKKS S.A.S.'s Long-Term IDR to 'CCC'

(The following statement was released by the rating agency) LONDON, April 07 (Fitch) Fitch Ratings has downgraded IKKS S.A.S.'s (IKKS) Long-Term Issuer Default Rating (LT IDR) to 'CCC'. Fitch has also downgraded HoldIKKS S.A.S.'s senior secured notes to 'CCC'/RR4 (50% recovery) and IKKS Group S.A.S.'s super senior revolving credit facility (RCF) to 'B-'/'RR2' (90%). The downgrade reflects the substantial credit risk to which IKKS's lenders are now exposed. This results from four quarters of negative like-for-like (LfL) sales, a contraction of consolidated EBITDA during 2016 and low visibility over a potential recovery of sales. In addition, the company now has significantly tight liquidity due in part to the fact that while covenants on the RCF have been temporarily reset, they remain tight in relation to the company's potentially weak performance in 2017. Finally, based on preliminary reported 2016 figures Fitch calculates that leverage has materially increased. Further trading underperformance could make the leverage positon unsustainable. KEY RATING DRIVERS Trading Underperformance: IKKS reported on 5 April 2017 a LfL revenue decline of -5.8% for 2016, resulting from consistently negative performance (LfL) during each quarter of the year (-0.8% in Q116, -4.1% in Q216, -16.3% in Q316, -3.4% in Q416) as the company's collections were not received well by customers and had to be marked down. IKKS's total revenue in 2016 only grew by 1.0% yoy and EBITDA contracted by 36%. This was in spite of significant store openings. We estimate that its 2016 EBITDA margin dropped to 12.4% (2015: 19.6%). Operational Challenges Continue: Execution risk has increased. The head of design at the main division IKKS Women, appointed in this role from mid-2014, has recently left the company. Her replacement will arrive in June 2017 but we believe it will take some time to turnaround IKKS Women's operating performance. IKKS's operating performance is likely to remain challenging in 2017 and we have consequently cut sales growth expectations for 2017-2019 to at best 1%, compared to 2-4% in our previous rating case forecasts. In the oversupplied clothing retail industry, repeated collection misses can quickly lead to customer disaffection and materially affect cash-flow generation. Weakening Free Cash Flow: IKKS has been persistently funding working-capital outflows over 2014-2016. In 2016 we we estimate that the EUR5.4 million outflow, although better than our forecast of EUR11 million, led to negative free cash flow (FCF) of EUR6 million. It is possible that through tighter working-capital controls and a shift of store openings towards the more asset-light model of affiliated stores, annual working-capital outflows may moderate to around EUR2 million between 2017 and 2019. Overall cash-flow absorption could be limited if the company's products sell well, but IKKS is exposed to a heightened risk of collection miss. Increasing Leverage: Based on our preliminary calculation, 2016 FFO-based net leverage has jumped to 8.7x from 2015's already high 6.7x. Based on our expectation of continued weak trading performance, in the absence of an equity injection from the company's equity sponsors, we do not expect this metric to fall below the negative sensitivity guidance of 8.0x over 2017-2019. Tight Covenant, Liquidity Headroom: Fitch expects an inventory-led slowdown of the cash conversion cycle to continue in 2017, leading to permanent use of IKKS's RCF and/or ancillary facilities of EUR30 million during the rest of the year, which will probably further increase by EUR5 million to EUR10 million in the third quarter when inventories tend to peak. The company will fully rely on debt drawdowns. IKKS has successfully reset the RCF maintenance covenant last September and has complied with the covenant at end-Q416 and end-Q117. However, any further EBITDA contraction would immediately put pressure on the already tight covenant headroom and prejudice the company's ability to draw on its RCF. Recoveries for Debt Instruments: Recovery rates for the debt instruments are based on Fitch's post restructuring going-concern estimate. Fitch applied a discount of 0% to the 2016 EBITDA of EUR42.7 million. After applying a distressed EV/EBITDA multiple of 5.0x and customary restructuring charges, the rating for the super senior RCF is 'B-' with a Recovery Rating 'RR2' reflecting a cap of 90% recovery rate for the French jurisdiction. We expect IKKS to frequently draw on an uncommitted ancillary facility separately provided, which currently amounts to EUR15 million. We treat this debt as a de facto committed line, and have included it as a super senior claim in the debt waterfall. The EUR320 million senior secured notes, which are secured by certain share pledges, bank accounts and intercompany receivables, are rated 'CCC', the same level as IKKS's IDR at 'CCC', derived from a Recovery Rating of 'RR4' (50% recovery rate). DERIVATION SUMMARY IKKS has a high concentration on France and its core brand IKKS Women. It is less well positioned than competitor Group SMCP in the affordable luxury clothing market. SMCP is more diversified geographically and its total revenue grew 16% in 2016. IKKS's total revenue only grew by 1.0% despite 82 new store additions. Compared to New Look Retail Group Ltd ('B-'/Stable Outlook), IKKS is about 5x smaller in total revenue. New Look reported a 3.2% revenue decline in the financial year to March 17, but its multichannel sales platform (stores, e-commerce, international and franchise) is a key differentiating and success factor in the fast-fashion business. New Look also has a more comfortable liquidity position than IKKS, with no material debt maturity until 2022. IKKS's FFO adjusted gross leverage is also higher than New Look's FFO adjusted gross leverage at around 7.0x. No Country Ceiling, parent/subsidiary or operating environment aspects impacts the rating. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - sales growth ranging from 0.2%-1% pa;. - EBITDA margins (incl. creation costs) around 13%; - inventory-led working-capital outflow around EUR2 million pa over 2017-2019; - capex at EUR15 million in 2017, falling towards EUR10m in 2019 (excluding creation costs); - EUR30 million to be drawn under the RCF in 2017-2019. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - Evidence of sustainable turnaround in sales and EBITDA trajectory - Improving liquidity position Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Further deterioration in trading performance leading the company towards default on its RCF - Breach of maintenance covenants of RCF resulting in further liquidity erosion LIQUIDITY Increased Reliance on External Liquidity: In order to support operations, most notably to finance working-capital needs, we have projected IKKS will consistently use the RCF and/or ancillary facilities for at least EUR30 million (EUR15 million drawn at end-2016), and generally more in the third quarter when inventory investments tend to be the highest. We project IKKS will still need to rely on its committed RCF and uncommitted bilateral facility to close its funding gap at the end of 2017. FULL LIST OF RATING ACTIONS IKKS S.A.S. -Long-Term IDR: downgraded to 'CCC', from 'B-'/Negative Outlook HoldIKKS S.A.S. -Senior secured bond: downgraded to 'CCC', from 'B' IKKS Group S.A.S -Super senior revolving credit facility: downgraded to 'B-', from 'B+' Contact: Principal Analyst Maggie Cheng, CFA Associate Director +44 20 3530 1689 Supervisory Analyst Elena Stock Director +49 69 76 80 76 135 Fitch Deutschland GmbH Neue Mainzer Strasse 46-50 D-60311 Frankfurt am Main Committee Chairperson Giulio Lombardi Senior Director +39 02 879087 214 Fitch Italia S.P.A. 20123 Milano, Via Morigi, 6. Summary of Financial Statement Adjustments: - Not readily available cash: Fitch estimates that IKKS will need to keep EUR15m of cash on balance sheet for trade working capital funding. - Operating leases: Fitch adjusted IKKS's debt by adding 8x of annual operating leases of EUR27.5m in 2016. - Financial debt reported by IKKS: adjusted by taking out EUR9.9m of accrued interest. - Shareholder loan: Fitch assigned 100% equity credit to EUR69.3m shareholder loan. - Creation costs: Fitch treated EUR5.6m capitalised creation costs in 2016 as SG&A and reduced capex accordingly. Summary of Financial Statement Adjustments - Not readily available cash: Fitch estimates that IKKS will need to keep EUR15m of cash on balance sheet for trade working capital funding. - Operating leases: Fitch adjusted IKKS's debt by adding 8x of annual operating leases of EUR27.5m in 2016. - Financial debt reported by IKKS: adjusted by taking out EUR9.9m of accrued interest. - Shareholder loan: Fitch assigned 100% equity credit to EUR69.3m shareholder loan. - Creation costs: Fitch treated EUR5.6m capitalised creation costs in 2016 as SG&A and reduced capex accordingly. Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com. 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