Fitch Downgrades Novartex SAS to 'CC'; Super Senior Debt to 'CCC-'
The downgrades follow management's public comments that it is discussing a new debt restructuring, reflecting the limited options available outside of the potential conversion of part of the group's debt into equity to address an over-leveraged balance sheet. During these restructuring talks, Vivarte remains within the terms of its liquidity covenant and will continue to service its debt.
The latest EBITDA underperformance leads to higher leverage, eroding the group's liquidity, which was to be primarily dedicated to its operational restructuring. This creates a cycle where growing uncertainty over management's capacity at turning around the business further hampers the implementation of its strategic initiatives. While the group should have sufficient liquidity to service its debt in the near-term, refinancing risks will be excessive as both the absolute EBITDA level and liquidity are likely to be insufficient by FY19. In our view, this implies an unavoidable debt restructuring.
In the event of a successful execution of a distressed debt exchange (DDE), Fitch will then likely assign an appropriate IDR for the issuer's post-exchange capital structure, risk profile and prospects. Key elements in our assessment will be a clear and stabilised strategic plan, in addition to certainty over near-term material progress in EBITDA generation.
KEY RATING DRIVERS
Upcoming Debt Restructuring
The downgrade directly reflects management's announcement on 25 July 2016 that it was starting discussions regarding a new debt restructuring, following the one completed in December 2014. Fitch believes this is prompted by the group's clearly unsustainable capital structure with regard to the progress made so far in profitability. Under management's current strategic plan, Fitch projects funds from operations adjusted gross leverage will remain above 10.0x over FY16-FY19 (FY15: 18.9x). This would heavily compromise a successful debt refinancing in FY19.
The ongoing EBITDA underperformance, related to external and internal factors, further undermines liquidity, which in turn, inflates the execution risk associated with management's turnaround initiatives.
Challenging Market Environment
In its rating case, Fitch factors in an increasing competitive gap - detrimental to Vivarte - between the players that have quickly adapted their business model to new consumer habits (low-cost and fast-fashion offer, omni-channel model) and the more traditional ones. These have to face decline in footfall and strong price pressures that compress their margins. The ongoing underperformance of Vivarte's main footwear banner, La Halle Footwear, reflects its lack of adaptation to new market conditions. Furthermore, we expect abnormal weather conditions to continue creating additional market disturbances, as this may lead retailers to continuously undertake deep discounting to keep their inventories at a reasonable level.
Subdued EBITDA Generation
Fitch has revised its FY16 EBITDA expectations to around EUR74m (stable from FY15) down from EUR120m under our previous rating case. The successful execution of Vivarte's cost savings plan and the stronger than expected recovery in its main clothing business, La Halle Apparel, was more than offset by the continuous decline of its footwear activities.
Sales were affected by external events such as the November 2015 terrorist attacks and abnormal weather conditions in both autumn 2015 and the spring/beginning of summer 2016. However, the EBITDA drop of La Halle Footwear primarily stems from an ill-executed repositioning towards a more attractive offering and lower prices, making it unable to face strong competition from Chaussea, Gemo or Kiabi.
Group Complexity
Fitch views the group's complexity as an additional factor of execution risk in the current turnaround strategy. This dilutes management' resources in the context of a highly competitive environment, while making them consistently oscillate between a global group and a subsidiary-by-subsidiary turnaround plan. In our view, this is illustrated by the contrast between La Halle Apparel's recovery, supported by an improvement in offer, merchandising and inventory management, and La Halle Footwear's decline.
Fitch positively views management's recent decision to sell its Kookai, Chevignon and Pataugas brands. Although it is likely to result in only marginal proceeds, it should help focus on larger subsidiaries with higher recovery potential.
Weakening Liquidity
Fitch expects the group to have sufficient liquidity to meet interest payments in the near term. However, a persistent lack of EBITDA recovery could lead to growing difficulties at renewing the group's letters of credit (used to fund its working capital needs) leading to an accelerating cash burn and diminishing resources to fund management's turnaround plan. This could turn into a self-fulfilling liquidity crisis.
Fitch expect that a successful debt restructuring in the coming months, if agreed, would help management to better focus on the operating turnaround while improving confidence in the group's providers of letters of credit. This would ensure easier yearly renewal and thus a consistent liquidity buffer.
Going Concern Recoveries
Fitch continues to assess recoveries of the group's debt under a going concern approach to the business, using a EUR100m EBITDA (down from around EUR125m in our previous analysis) and a 5.0x multiple in deriving a post-distress valuation. This approach reflects our view that the core underlying group business remains viable but that profit recovery could be unpredictable or take longer than previously expected considering the group's current performance. The multiple continues to reflect the potential attractiveness of Vivarte's large physical network.
Under these assumptions, Vivarte's super senior secured debt lenders could expect a recovery rate in the low end of the RR3 range (51%- 70%), leading to an instrument rating of 'CCC-'/RR3. Accordingly, we assess the Reinstated Debt's Recovery Rating at 'C'/RR6 reflecting weak recovery prospects in case of default.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Vivarte are based on management's current strategic plan and include:
- Sharp decline of sales in FY16 and FY17, due to weak performance in spring/summer 2016 and disposal of some brands.
- EBITDA at EUR74m in FY16, recovering in FY17 and FY18 mostly thanks to the disposal of some non-profitable businesses.
- Average EUR100m annual capex over FY16-FY19, including EUR50m strategic capex split between FY17 and FY18.
- EUR250m non-recurring items (restructuring, discontinuing operations and inventories clearance) split between FY16, FY17 and FY18.
- EUR65m cash disposal proceeds split between FY16 and FY17.
RATING SENSITIVITIES
Future developments that may, individually or collectively, lead to negative rating action include:
- We believe there is a high probability of some form of debt restructuring (or DDE as defined by Fitch) by end-2016. Assuming such formal debt restructuring proposal will result in economic loss or material change in terms to certain set of creditors, on announcement of the terms of the debt exchange, we will likely downgrade the IDR to 'C' and subsequently to 'RD' on completion.
-If restructuring talks take longer than expected, we will also consider a meaningful deterioration in liquidity buffer or suspension of debt service credit negative events.
Future developments that may, individually or collectively, lead to positive rating action include:
Fitch currently does not envisage a positive action under the existing capital structure.
After completion of the DDE, Fitch will assign an appropriate IDR for the issuer's post-exchange capital structure, risk profile and prospects subject to our assessment of sustainable leverage and refinancing risk, along with a turnaround plan (to be announced in September 2016) which is clear and stabilised.
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