Belk, Inc.’s debt ratings were downgraded by S&P Global Ratings as the southeast department store operator’s sales and profitability have weakened significantly, well below S&P’s expectations.
S&P’s issuer credit rating on Belk was lowered by ‘CCC-‘ from ‘CCC+’ reflecting weakened consumer demand, thinning liquidity, and approaching maturities. At the same time, S&P’s issue-level rating on the company’s $300 million first-lien first-out (FLFO) term loan was reduced to ‘CCC’ from ‘B-‘ and its issue-level ratings on its $815 million first-lien second-out (FLSO) and $110 million second-lien term loans to ‘C’ from ‘CCC-‘. The recovery ratings on the debt of ‘2’ and ‘6’, respectively, are unchanged.
The negative outlook reflects S&P’s expectation that Belk will likely restructure its credit facilities given its onerous capital structure and weak performance prospects.
S&P said in its analysis, “The downgrade reflects Belk’s poor operating trends and limited prospects for a sustained recovery. Belk’s operating performance through the third quarter of fiscal 2023 (ended Oct. 29, 2022) deteriorated year-over-year with higher markdowns and significant cash burn. This was despite modest sales growth in the quarter. For the trailing 12 months ended in October 2022, S&P Global Ratings-adjusted EBITDA margins of about 6 percent were well below our expectations for high-single-digit margins. We also believe the fourth quarter likely remained weak because other department stores have announced contracting sales and margin pressures amid increased discounting. Further, we expect little recovery in profitability this year because of softening demand and a mild recession. This is despite seeing abating pressure from freight costs. We, therefore, expect continued weak credit metrics, including very high leverage well over 10x, and negative free operating cash flow (FOCF) to either persist or accelerate in the coming year.
“Belk has invested heavily in its omnichannel capabilities over the past several years, enabling it to capture some of the shift in demand to e-commerce sales that partially offset weakness in its stores. Based on the highly competitive online retail landscape and Belk’s relatively small size, we do not expect online sales to fully recapture lost brick-and-mortar revenue.
“We believe the company’s capital structure is unsustainable and will likely be addressed through some type of restructuring. Belk’s turn-around efforts have not succeeded in a sustained improvement in EBITDA and cash flow since the 2021 bankruptcy emergence. The capital structure put in place at that time required significant improvement in profitability to become sustainable and this looks increasingly unlikely. Belk emerged from bankruptcy in early 2021 with a capital structure that includes payment-in-kind (PIK) elements that will partly reverse in the near term. The PIK option available on the $815 million FLSO term loan due July 2025 expires this year. This results in cash interest requirements stepping up to 10 percent from 5 percent. The $110 million second-lien term loan maturing July 2025 accrues PIK interest of 10 percent, with no cash coupon. The incremental cash interest expense will likely overlap ongoing challenges in sales, profitability, and cash flow. Belk also had over $500 million of borrowings under the $900 million asset-based lending (ABL) revolving credit facility due August 2024, which reflects peak seasonal borrowings. The facility will go current this summer absent an extension. We also view liquidity as constrained by Belk’s very large debt burden totaling $1.9 billion as of the third quarter (including PIK amounts on its term loans over the past couple of years).
“Leverage covenants on its term loans are not effective until the end of fiscal 2023 (ending February 2024). However, a minimum liquidity covenant on its FLFO term loan requires the company to maintain at least $40 million of liquidity and a springing 1x fixed-charge covenant limits its ability to access the full ABL borrowing base. We forecast sufficient liquidity to comply with these requirements, but unfavorable market conditions relative to our forecast could result in covenant pressure.
“The negative rating outlook on Belk reflects our forecast for difficult operating conditions and its highly uncertain path to recovery. We believe the company is dependent on favorable market conditions to meet its financial obligations and its liquidity position may deteriorate over the next 12 months.”