Moody’s Investors Service downgraded The Gap, Inc.’s debt ratings due to expectations that “topline growth and margin expansion will be limited in the next 12 months due to continuing inflationary and competitive pressures.”
Gap’s corporate family rating (CFR) was lowered to Ba3 from Ba2, and its probability of default rating (PDR) was reduced to Ba3-PD from Ba2-PD. At the same time, Moody’s downgraded the rating of Gap’s senior unsecured notes to B1 from Ba3. The speculative grade liquidity rating (SGL) remains unchanged at SGL-2. The outlook remains negative.
Gap’s banners include Gap, Old Navy, Athleta, and Banana Republic.
“The downgrade reflects the weaker than expected operating performance and our expectation that credit metrics will remain weak as topline growth and margin expansion will be limited in the next 12 months due to continuing inflationary and competitive pressures,” Moody’s Vice President Mickey Chadha stated. “The uncertain macro-economic environment and the consumer focus on discretionary versus non-discretionary purchases due to shrinking disposable income will make it challenging to change the current operating performance trajectory meaningfully in fiscal 2023, hence the negative outlook,” Chadha further stated.
The downgrade also reflects governance considerations, notably that Gap, Inc. continued to make moderate share repurchases in 2022 despite significantly weakening operating performance. The company’s governance issuer profile score was lowered to G-3 (moderately negative) from G-2 (neutral to low). The change in its governance score is primarily related to the company’s weaker financial strategy and risk management as well as management credibility and track record scores as credit metrics have weakened considerably and are not expected to improve to historical levels in the next 12 months.
The company has had several management changes and has been operating under an interim CEO for most of the fiscal year 2022. Share repurchases totaled $123 million in fiscal 2022. Moody’s expects the company not to do any more share repurchases until free cash flow and credit metrics improve materially but will continue to pay dividends. The company’s credit impact score of CIS-3 (moderately negative) remains unchanged.
Moody’ said in its analysis, “The Gap, Inc.’s Ba3 corporate family rating reflects the company’s good liquidity and Moody’s expectation that Gap, Inc.’s currently weak credit metrics will begin to improve in 2023. The company’s debt/EBITDA and EBIT/Interest were weak at 4.9x and 0.3x, respectively, at the end of fiscal 2022. Moody’s expects an improvement in operating profit in fiscal 2023 as inventory levels have improved and input and freight costs are expected to be lower. However, revenue growth will be anemic as consumers withdraw from discretionary purchases due to economic uncertainty.
Moody’s expects the company to repay the $350 million revolver balance in 2023. Therefore, Moody’s estimates debt/EBITDA to improve but remain above 3.5x and EBIT/interest to stay below 2.0x at the end of fiscal 2023. Cost cuts and store rationalization will also help the bottom line with further improvement in profitability and credit metrics expected in 2024 provided the inventory assortment at all of the company’s brands, including its largest brand, Old Navy, improves and resonates with consumers. The rating is supported by the company’s good market position in the specialty apparel market with its ownership of specialty apparel brands, Old Navy, Gap, Banana Republic, and Athleta, and a relatively low amount of funded debt.
The relatively shorter term of its store leases (approximately five years) has enabled the right sizing of its mature brands (Gap and Banana Republic) while continuing to add stores to its higher growth concepts (Old Navy and Athleta). Investments in its online and mobile business have also strengthened its operational profile and improved its customer experience, and continued integration of its online and store experiences also supports its efforts to increase customer conversion.
“Gap, Inc.’s SGL-2 reflects good liquidity supported by its $1.2 billion in cash at the end of fiscal 2022 and about $1.85 billion available under its $2.2 billion asset-based revolving credit facility after considering the $350 million currently borrowed under the facility. Moody’s expects free cash flow to be modest in 2023. The company also owns sizable assets that it can monetize.
“The negative outlook reflects Moody’s expectation that the business environment, especially for apparel retailers, will remain very challenging, which can make it difficult for the company to improve operating performance and cause credit metrics and profitability to remain weaker than expected for a longer period of time.”
Photo courtesy Gap
