S&P Global Ratings revised its debt ratings outlook on PVH Corp. to positive as the parent of Tommy Hilfiger and Calvin Klein demonstrated a track record of maintaining leverage of less than 3x in recent years.
S&P noted that while it believes PVH will pursue sizable debt-funded acquisitions, management will subsequently prioritize reducing its leverage below 3x. S&P said its expectation for a challenging consumer environment over the next year poses some risk to its forecast, which includes a slow, but steady, expansion and stable margins that lead to leverage of well below 3x.
Along with revising its outlook on PVH to positive from stable, S&P affirmed all of its ratings on PVH, including the ‘BBB-‘ issuer credit rating. The positive outlook reflects that ratings could be raised if the company sustains its current credit metrics, including leverage of less than 3x, despite the challenging consumer environment and its belief that financial policy will support its maintenance of this level of leverage.
PVH’s brands also include Warners, Olga and True & Co.
S&P said in its analysis, “We expect PVH to maintain leverage in the 2x-to-3x range and anticipate it will prioritize deleveraging to this range if it pursues mergers and acquisitions (M&A).
“The company has maintained leverage of near 2x over the last two fiscal years and has not completed a sizeable debt-funded acquisition since its purchase of Warnaco in 2013. Despite not having a formal, publicly stated financial policy, we believe PVH has demonstrated a track record of sustaining leverage in the 2x-3x range since 2019 (excluding the peak of the coronavirus pandemic in 2020). We believe the company remains committed to a strong investment-grade rating, will prioritize debt reduction, and avoid pursuing debt-funded acquisitions that would prolong the achievement of its PVH+ plan margin targets. PVH repurchased $200 million of stock in the second quarter of 2023, with the intent to repurchase up to another $200 million in the second half of 2023, under its $1 billion authorization ($623 million remaining). We forecast the company’s leverage will be in the low-2x area after incorporating its share repurchase activity. Over the longer term, we believe PVH will expand its brand portfolio and product categories via acquisitions. While we believe it would be willing to increase its leverage above 3x for the right target, we anticipate it would quickly deleverage below 3x.
“PVH’s credit metrics are heavily dependent on its performance in the back half of the year and the holiday season.
“The company reported a 4 percent increase in its sales for the second quarter of 2023 and improved its S&P Global Ratings adjusted gross margins by 60 basis points (bps) on lower freight costs. That said, its S&P Global Ratings adjusted EBITDA margin declined almost 200 bps on a rolling-12 month basis due to restructuring costs, higher marketing spend and shift to DTC. PVH’s leverage increased slightly over the 12 months ended July 2023 to 2.4x because of lower adjusted EBITDA and cash used to fund its share repurchases in the second quarter. We forecast the company will generate positive free operating cash (FOCF) and just under $1 billion of cash flow from operations, which will reduce its leverage to the low-2x area by the end of the fiscal year. However, this forecast is highly dependent on PVH’s ability to reduce its inventory without a heavy reliance on promotions during the critical holiday season.
“We expect management’s PVH+ plan will improve the company’s margins and restore its brand equity in North America.
“In 2022, PVH announced that it would bring certain categories in-house, shifting away from its current licensing model, to elevate and decrease its exposure to discount retailers. The plan, which was created by its relatively new management team, aims to create healthier brands, expand its annual revenue to $12.5 billion, elevate its margins toward 15 percent, and generate $1 billion of FOCF by 2025. The plan focuses on leading with direct-to-consumer (DTC) and digital sales while elevating consumer engagement and store experience, both in its own retail network and full-price wholesale channel. The plan also calls for improving its supply chain to provide shorter lead times and better demand planning on assortments, which will lead to more accurate deliveries and better product availability to meet demand on a regional basis. We believe the company’s achievement of these goals will be delayed due to the challenging consumer environment and increasing competition, though we forecast it will continue to modestly improve its revenue and credit measures.
“We estimate the licensing deal for its Calvin Klein and Tommy Hilfiger womenswear and jeanswear businesses with its long-term U.S. licensing partner, G-III Apparel Group Ltd., generated approximately $2.5 billion of retail sales in 2022. The agreements will expire from December 2023 through December 2027 as PVH takes the brands fully in-house. We estimate PVH’s Calvin Klein fragrance product line with Coty Inc. will be a $1 billion global business, which we expect it will leave in place because it does not have fragrance manufacturing expertise. We view the royalty income stream as important to the company, despite it only accounting for approximately 4 percent of its overall revenue, because of its high margins. We estimate this royalty stream now comprises approximately about 20 percent of PVH’s EBITDA.
“With approximately $9 billion of revenue as of the end of fiscal year 2023, PVH is a global leader in lifestyle brands.
“The company’s business is concentrated in two multi-billion dollar brands, Calvin Klein (about 40 percent of revenue) and Tommy Hilfiger (about 50 percent of revenue). We believe these brands will continue to resonate well with consumers because they both can shift between sportswear, casualwear, and dressier apparel categories. Overall, PVH generates 43 percent of its revenue from DTC, 52 percent from wholesale and 5 percent from licensing and other. The company is also well diversified globally and generates more than 65 percent of its revenue and profit from outside the U.S. Additionally, PVH historically derived about 30 percent-40 percent of its U.S. sales are from international tourists, the volumes of which are still recovering and have not yet returned to pre-pandemic levels. The company’s expansion in Europe and Asia continues to outpace its performance in the domestic market and its brands resonate well with international consumers. We believe this is because Europe and Asia have more established apparel, digital wholesale, and third-party partners–such as Zalando, Asos, T-Mall, and JD–which appeal to millennial and Generation Z consumers. PVH’s shift to digital and away from brick-and-mortar will benefit its gross margins over the long term.
“The positive outlook reflects that we could raise our ratings on PVH over the next 12-to-24 months if it continues to demonstrate a conservative financial policy amid the challenging consumer environment.”
Photo courtesy Tommy Hilfiger
