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Fitch Places New Look's 'B-' IDR on Rating Watch Negative
June 13, 2017 / 5:00 PM / 6 months ago

Fitch Places New Look's 'B-' IDR on Rating Watch Negative

(The following statement was released by the rating agency) LONDON, June 13 (Fitch) Fitch Ratings has placed New Look Retail Group Ltd (New Look)'s 'B-' Long-Term Issuer Default Rating (IDR) on Rating Watch Negative (RWN). The RWN reflects New Look's deteriorating operating performance, our expectation of falling consumer confidence in the UK, rising input prices following the fall in sterling, economic uncertainty following the recent general election, exacerbated by heavy competition from pure online players. The RWN for the IDR and also the ratings for the instruments will be resolved following full review with management on their 2018 business strategy. The stabilisation of the Outlook will be subject to our confidence in management's ability to turn around their operating performance, maintain their business profile, remain competitive in a rapidly changing environment and improve their financial and liquidity profile back within our negative sensitivity guidance. KEY RATING DRIVERS Exposure to UK Uncertainty: Fitch expects continuing pressure on UK like-for-like (LFL) sales as the UK's exit from the EU which continues to weigh on consumer spending. New Look's significant exposure to the UK, which together with rising input prices following the fall in sterling, economic uncertainty following the recent general election, intense competition and the significant challenges ahead over the coming years supports our RWN for the company's rating. Eroding Margins: In our base case, we have revised our expectations for EBITDA margin to only slightly recover to 11.9% in the financial year to March (FY18) from 10.4% in FY17. We have also revised downwards our view on the business model to 'Intact' from 'Sustainable' given the structural change in the fast fashion sector in the UK. We expect margins to remain under pressure, mainly due to the heavy discounting in the UK, in addition to sterling's depreciation against the US dollar, which will further impact pricing and competitiveness when New Look's legacy hedges roll off during 2017. This should be partially offset by growth in e-commerce channels. New Look experienced a significantly poor fourth quarter in FY17, with EBITDA down GBP22 million to GBP151million from our full-year Fitch forecast of GBP173million. Of the GBP 22million decline that occurred in the last quarter, about GBP10 million is related to product (fashion) risk in the UK, and GBP 15m to discounting due to the prevalence of promotions as well as increased distribution, marketing and e-commerce costs related to organic growth. If this trend continues, this could put further pressure on the ratings. Weaker Free Cash Flow; Credit Metrics: Free cash flow (FCF) has become negative and is not expected to recover to previous levels in the near term. This has reduced liquidity although it remains manageable. We expect the FCF margin to be negative to reach -0.3% in FY18 and -1.2% in FY19. FFO adjusted leverage has increased to 8.5x in FY17, which is 1.0x higher than our previous Fitch forecast and in the absence of a significant improvement in operating performance, we only expect slight deleveraging to 8.0x by FY19, which is just on our 8.0x negative guidance. New Look's leverage increased following a refinancing in 2015 from 7.1x, this reduced headroom under its negative guidance. Financial flexibility has also weakened slightly with FFO fixed charge cover falling to 1.2x in FY17, although it is expected to recover to around 1.3x by FY19. DERIVATION SUMMARY New Look is a fast-fashion multichannel retailer operating in the value segment of the UK clothing and footwear market for women, men and teenage girls. The group also generates around 20% of revenue internationally. The e-commerce platform is a key differentiating factor relative to other sector peers such as Financiere IKKS S.A.S (CCC), which helps to offset weaknesses in the domestic UK retail market to which it is heavily exposed. 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: - group revenue growth declining -0.4% for FY18, driven by continued challenging conditions in the UK, pricing pressure, intense competition, partially offset by growth in ecommerce and international (China) - EBITDA margin recovering to 11.9% in FY18 - capex steady at 4.5% of sales in FY18 - no dividend payments or extraordinary non-recurring cash outflow RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - Improvement in the business model through successful expansion in China, increasing diversification and scale, and a proven track record of strategy implementation over the medium term, leading to EBITDA margin at or above 15% - FFO adjusted leverage consistently below 6.5x - FFO fixed charge cover trending towards 2.0x - FCF margin sustainably above 2% Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Failure to overcome profit margin pressures, FX impact, loss of market share and weaker consumer confidence in the UK leading to EBITDA margin below 10% (FY17: 10.4%) - FFO adjusted leverage above 8.0x on a sustained basis (FY17: 8.5x) - FFO fixed charge cover below 1.2x (FY17: 1.2x) - Negative FCF generation (which Fitch defines after dividends) eroding the group's liquidity buffer (FY17: Neg) LIQUIDITY Weaker Liquidity: Cash balances have declined, lowering the overall liquidity buffer. New Look had GBP72 million of cash at FYE17, together with access to a GBP 100million undrawn RCF and a bilateral GBP5 million overdraft. There is a springing covenant under the RCF when more than 25% of its total commitment is drawn, requiring net leverage to be below 8.7x at FYE18 (and below higher levels at the end of the first, second and third quarters) against our estimate of 7.9x at FYE18. Working capital peak to trough is in the range of GBP50-60 million, for which we set aside GBP50 million as restricted cash. Refinancing risk has risen although there are no significant debt maturities of the notes until 2022. Contact: Principal Analyst Timothy Li Director +44 203 530 1386 Supervisory Analyst Jean-Pierre Husband Director +44 203 530 1155 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chairperson Edward Eyerman Managing Director +44 203 530 1359 Summary of Financial Statement Adjustments - Fitch has adjusted the debt by adding 8x of yearly operating lease expense related to long-term assets in the UK (around GBP173million for FY18) and 7x related to a small portion of group operating leases in Poland. Fitch also sets aside an amount of GBP50m as restricted cash related to working capital requirements. 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