S&P Global Ratings revised its debt ratings outlook on Authentic Brands Group (ABG) to stable from negative due to stronger-than-expected third-quarter results ended Sept. 30, 2020. The rating agency also expects sustained improvements over the next year.
S&P said ABG maintained revenues and grew profitability despite weak industry fundamentals because of continued collections of guaranteed licensing revenues, strong e-commerce growth, and cost-cutting initiatives. S&P previously expected the weak economy and pandemic-related restrictions to hurt its customers, resulting in weaker collections of licensing revenues.
As a result, S&P Global Ratings has revised its forecasts and expects modest sales and profit growth in fiscal 2021, leading to significant improvements in its credit metrics. This includes leverage falling below 5x and discretionary cash flow of about $175 million.
ABG’s portfolio of brands generates more than $14 billion in annual retail sales and includes Marilyn Monroe, Elvis Presley, Muhammad Ali, Shaquille O’Neal, Sports Illustrated, Dr. J, Greg Norman, Neil Lane, Thalia, Nautica, Aéropostale, Forever 21, Juicy Couture, Vince Camuto, Herve Leger, Judith Leiber, Barneys New York, Brooks Brothers, Frye, Lucky Brand, Nine West, Jones New York, Frederick’s of Hollywood, Hickey Freeman, Hart Schaffner Marx, Adrienne Vittadini, Bandolino, Spyder, Tretorn, Tapout, Prince, Volcom, Airwalk, Vision Street Wear, Thomasville, Drexel, and Henredon.
S&P also affirmed the ‘B’ issuer credit rating on the company. At the same time, S&P affirmed the ‘B’ issue-level rating on the company’s $100 million senior secured revolving credit facility due June 2024, $1.6 billion senior secured term loan due September 2024, and $200 million incremental first-lien term loan maturing in September 2024. The ‘3’ recovery rating is unchanged and indicates its expectation for 50 percent to 70 percent recovery; rounded recovery, 50 percent.
S&P wrote, “The stable outlook reflects our expectation that improving demand and incremental contribution from acquisitions will support improved earnings, driving stronger credit metrics compared to our previous expectations when the pandemic began. ABG has demonstrated improving revenue and profit trends during the third quarter of fiscal 2021, which ended September 2020, after experiencing modest deterioration earlier in the year due to the weak economy and nationwide closure of retail locations that hurt their customers. We estimate ABG’s proforma adjusted leverage amounted to 5x for the 12 months ended September 30, 2020. We previously believed that lower demand due to pandemic restrictions would pressure profitability and could lead to leverage sustained above our 7x downgrade threshold.
“We forecast low-double-digit percentage EBITDA growth in 2021 mainly driven by a rebound in volumes at customers’ retail stores and incremental contribution from recent acquisitions. We believe that ABG will remain disciplined with costs and sustain the benefits of some of the cost-cutting efforts undertaken in fiscal 2020 as sales recover, thereby maintaining adjusted EBITDA margins of about 70 percent. We also expect the company to continue to be acquisitive and utilize future cash flows to fund additional acquisitions. As a result, we expect leverage to improve to below 5x over the next 12 months. Our measure of leverage includes approximately $47 million of term loan draw out of its $600 million committed credit facility at ABG-SPV 1 LLC, which we consolidate under the parent company, Authentic Brands Group LLC.
“ABG’s resilient operating performance was supported by strong licensing revenue collections, e-commerce growth and benefits from cost-cutting initiatives. ABG’s organic sales declined at a double-digit percentage for the nine months ended September 30, 2020, over the same period a year ago because of lower consumer traffic to its customers’ retail stores. However, sales from the e-commerce channel increased significantly as a result of traffic shifting online and high conversion rates. Recent acquisitions, Forever 21 and Lucky Brand in the most recent quarter and Volcom and Sports Illustrated in early 2019, made strong contributions to sales and profitability. The company’s focus on the collections of guaranteed royalties in a difficult macroeconomic environment continued to provide a stable revenue stream, which we previously believed could be at risk due to severe economic pressures and bankruptcy risk for the company’s customers. However, the company’s customers proved resilient and have met their payment commitments. Moreover, the company’s proactive efforts to reduce employee costs and lower advertising spend while repurposing its marketing dollars to support e-commerce growth resulted in more than $35 million of annualized cost savings and allowed it to expand profitability margins by more than 400 basis points (bps) in the quarter ended Sept. 30, 2020, compared with the same period the prior year.
“The company’s strong profitability and its asset-light business model should support continued good cash flow generation. We expect the company to generate discretionary cash flow, free cash flow after-tax distributions, of at least $175 million in fiscal 2021. ABG’s licensing business model is asset-light with modest annual capital expenditure (Capex) requirements of $5 million to $10 million. The company earns guaranteed minimum royalties for use of its brands, thereby providing a stable and predictable stream of recurring revenues through multi-year contracts. Moreover, since the licensee is responsible for the design, manufacturing, logistics, and, working capital management, the company is able to maintain a very lean cost structure. The company leveraged its primarily variable cost structure at the start of the pandemic to cut costs quickly and maintain profitability and liquidity.
We believe the company will remain acquisitive under its financial sponsor ownership, keeping leverage above 5x. The company has increased more than three times in size over the past five years given its aggressive acquisition history. We believe the company will continue to seek out acquisition opportunities, with help from the current retail industry landscape that is causing secular declines for several apparel and footwear players. Most recently, ABG purchased a 50.0 percent stake in the intellectual property of Brooks Brothers for $63 million after it filed for bankruptcy. While we have not modeled in material debt-funded acquisitions, we believe ABG will maintain adjusted leverage of 5x-6x longer term due to the company’s majority ownership by its financial sponsors. We also expect the sponsors could seek a return on their investment with the potential to extract returns in the form of debt-financed dividends.
“The stable outlook reflects our belief that the company will successfully integrate its most recent acquisitions, and credit metrics will improve over the next 12 months through operating gains as retail volumes rebound and incremental EBITDA from the recently acquired brands. We expect leverage to remain at or above 5x because of the company’s acquisitive growth strategy and the potential for additional debt-funded acquisitions and dividends to the financial sponsor owner.”
Logo courtesy ABG
