Apparel Retailer SMCP Group On CreditWatch Positive On Likely Improving Credit Metrics After IPO

Stocks and Financial Services Press Releases Wednesday October 11, 2017 17:26
PARIS--11 Oct--S&P Global Ratings
PARIS (S&P Global Ratings) Oct. 11, 2017--S&P Global Ratings said today that it had placed its 'B' long-term corporate credit rating on SMCP Group on CreditWatch with positive implications.

We have also placed on CreditWatch our 'BB-' issue rating on SMCP Group's super senior revolving credit facility (RCF) due 2022. Our recovery rating remains '1' on this instrument, reflecting our expectation of very high recovery (95% rounded estimate) in the event of default.

Likewise, we placed on CreditWatch our 'B' issue rating on the group's €434 million senior secured notes. Our recovery rating remains '3' on this instrument, reflecting our expectation of average recovery (50%-70%, rounded estimate: 50%) in the event of default.

The CreditWatch placement reflects the possibility that we could raise our ratings on SMCP Group, if the IPO launches and completes successfully.

The group intends to use part of the IPO proceeds to redeem its €100 million floating senior secured notes due 2022 and up to €111 million of the €334 million fixed rate senior secured notes due 2023 outstanding. For that purpose, the group is refinancing its €70 million RCF with an upsized €250 million one, on which it expects to partially draw upon completion of the IPO.

We view the IPO and the related debt buybacks, if successful, as positive from a credit perspective, as they will allow SMCP Group to deleverage materially, notably because the group's existing €300 million payment in kind instrument will be extinguished.

We also believe the proposed evolution of ownership and corporate governance could have positive implications on our rating on SMCP Group. At the moment, the 'B' rating on the broader Shandong Ruyi Group constrains the rating on SMCP Group at 'B'. After the transaction, we believe that Shandong Ruyi's influence and weight over SMCP Group's strategy, albeit still controlling 51%, would be subject to the oversight of the board of directors that will represent the significant interests of minority shareholders and employ four independent directors out of 12 in total.

Additionally, we consider that the legal framework in France protects SMCP Group from a bankruptcy of the parent, in particular due to their distinctly separated capital structures, no material overlap in lender groups of the two companies, and in absence of any guarantees or cross-default clauses between the subsidiary and its parent. Consequently, once SMCP Group is listed and the new governance structure is in place, we could consider SMCP Group as an insulated subsidiary, and as such rate it higher than its parent company Shandong Ruyi.

That said, in our view, SMCP Group remains a subsidiary with moderately strategic importance to its ultimate parent, Shandong Ruyi Group. We view its investment in SMCP Group as beneficial to Shandong Ruyi Group's longer-term strategy, providing the group with investment diversification into the European market, while also providing the potential for some synergies, such as supporting SMCP Group's continued penetration strategy into Asia.

SMCP Group reported solid results in 2016. It generated positive free operating cash flow and achieved a meaningful level of deleveraging, highlighted by a debt-to-EBITDA ratio of 5.5x on an S&P Global Ratings-lease-adjusted basis for fiscal 2016 versus about 6.0x anticipated in our initial base case for 2016. Nonetheless, under the current capital structure, SMCP Group remains highly leveraged.

Our view of SMCP Group's operating model is supported by its brand and geographic diversification, allowing it to cope with the inherent fashion risk it faces. That diversification, paired with the group's choice to have a business model weighted heavily toward directly operated stores representing over 90% of sales, provides the company with greater control and responsiveness, allowing it to capitalize on market trends and meet customer demand. The group's track record of pursuing a prudent execution strategy and its efficient supply chain are also key supporting factors.

However, the fragmented and competitive nature of the accessible luxury sector is among the constraints to the rating, notably because of increased online competition leading to greater price transparency and pressure on margins. We also believe that the flip side to SMCP Group's important retail network is a high level of fixed costs that leaves the group with a limited buffer in case of collection issues. Lastly, the group's limited diversification into menswear and lack of offer in children's wear makes it somewhat more subject to volatility swings.

We view the group's risk management as generally prudent, but believe bolt-on acquisitions the group could finance thanks to its increased RCF could erode liquidity.

We expect to resolve the CreditWatch in conjunction with the completion of the IPO and sufficient information on the new RCF. Our initial view is that we could upgrade SMCP Group based on the prospective capital structure. The upgrade could also stem from the fact that, once the company is listed and the new governance structure is in place, we could consider SMCP Group as an insulated subsidiary, and as such we can rate it higher than its parent company Shandong Ruyi.

If the IPO doesn't succeed, or succeeds but in different terms that what was initially expected, or if we have in the meantime any material information suggesting that SMCP Group is more strategic to Shandong Ruyi than what we had anticipated, we could affirm the rating at the current level.


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