S&P Downgrades Gap, Inc. (GPS) to 'BB+'; Outlook Stable
S&P Global Ratings lowered the corporate credit rating on The Gap Inc. (NYSE: GPS) to 'BB+' from 'BBB-'. The outlook is stable.
We lowered our rating on the company's senior unsecured debt to 'BB+' from 'BBB-' and assigned a '3' recovery rating, which reflects our expectation for meaningful recovery in the event of default at the high end of the 50% to 70% range.
"The rating action reflects the company's continued weakened operating performance, a trend we expect to persist in at least the next 12 months," said credit analyst Helena Song. "We think negative same-store sales across all its three major brands, (Gap, Old Navy, and Banana Republic) and continued margin decline is likely for the rest of this year despite closing 15% of its North American Gap stores last year and its recent announcement of closing selected Old Navy and Banana Republic stores internationally. Moreover, we believe meaningful industry headwinds have more than offset the company's various operating initiatives and hurt the company's competitive standing on a sustained basis, as the company has weakened brand appeal and lost share to fast fashion retailers, online competitors, and off-price retailers. As a result, we are revising our assessment of Gap's business risk to fair."
The stable outlook reflects our expectation that although operating performance will remain relatively weak at Gap's major brands in the next 12 months, the company will use its good free operating cash flow and meaningful cash balance to maintain generally stable credit metrics, including debt to EBITDA in the low- to mid-2x range. This incorporates our assumption that share repurchases will be managed to keep cash balances substantial.
We could lower the ratings if the company undertakes a more aggressive financial policy, including raising additional debt to return capital to shareholders, such that leverage approaches the 3x area. We would also lower the ratings if the company underperforms our base-case expectation significantly, with accelerating or prolonged meaningful sales declines across its three major brands and further meaningful EBITDA margin contraction, resulting in leverage in the 3x area.
A higher rating is unlikely in the near term, given our expectation of the challenging operating environment and the company's negative operation trends. Still, we could raise the ratings in the longer term if the company improves operating performance with positive same store sales supported by effective merchandising, resulting in debt leverage sustained in the mid- to high-1x range. This could happen if sales grow by 8% and EBITDA margins expand meaningfully by 200 basis points while debt remains generally consistent. We would also need to believe the company is committed to a financial policy that supports a sustained lower leverage.