S&P Global Ratings raised its debt ratings outlook on Caleres to Stable From Negative as it expects the company’s operating performance to continue to gradually improve in 2021, spurred by the expected healthy recovery in sales of its retail business’ wellness, comfort, and sport styles apparel shoes.
The rating agency also affirmed its ‘B+’ issuer credit rating on the company. At the same time, S&P raised its rating on the company’s senior unsecured notes to ‘B+’ from ‘B’ and revised the recovery rating on the notes to ‘4’ from ‘5’ as a result of its debt pay-down to date from peak borrowings during the pandemic.
The stable outlook reflects S&P’s expectation that Caleres will continue to improve its operations over the next 12 months, driven by positive top-line and earnings trends at its Famous Footwear segment leading to leverage improving to the mid-to-high-3x area over the next year. S&P also said it expects the Brand Portfolio segment’s performance to gradually become stable in the second half of 2021 as consumer demand for dress and formal footwear remains challenged and that the company will continue to demonstrate a balanced financial policy.
S&P said in its analysis, “We expect the resilient fourth quarter of 2020 operating performance at its Famous Footwear Stores will set the tone for a steady recovery in 2021, with adjusted leverage improving to the mid-to-high 3x area. We expect the company’s Famous Footwear (FF) segment (about 53 percent of pre-pandemic fiscal 2019 sales) to continue its gradual recovery in fiscal 2021 (ending Jan. 31, 2022) as consumer demand for casual and active styles will remain strong. The fallout of COVID-19 significantly hit Caleres’s operating performance in fiscal 2020, with sales for the consolidated company decreasing by about 27 percent compared with fiscal 2019.
“However, declines in sales at FF moderated sequentially and were limited to negative 6 percent in the fourth quarter of 2020 compared with the same period in 2019, with comparable-store sales only down 1.8 percent. This stronger-than-expected recovery in sales was driven by both strong consumer demand for its comfort and sport offerings and increased digital sales penetration (about 33 percent at year-end), supported by the company’s previous investments in its e-commerce system. The FF segment also benefited from improved prospects in its kid’s business and continued uplift from its rewards program. We expect FF’s revenue to grow in the high-teens percent area in 2021 to nearly pre-pandemic levels, similar to the company’s recently upped guidance that FF would meet or exceed its first-quarter 2019 sales levels. As a result, we now forecast the company to maintain leverage in the mid-to-high-3x area, compared with our previous expectations at the start of the pandemic for a slower recovery and higher leverage.
“S&P Global Ratings believes there remains high, albeit moderating, uncertainty about the evolution of the coronavirus pandemic and its economic effects. Vaccine production is ramping up and rollouts are gathering pace around the world. Widespread immunization, which will help pave the way for a return to more normal levels of social and economic activity, looks to be achievable by most developed economies by the end of the third quarter. However, some emerging markets may only be able to achieve widespread immunization by year-end or later. We use these assumptions about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here). As the situation evolves, we will update our assumptions and estimates accordingly.
“The adequate liquidity, stable cash flow, and balanced financial policy (or company’s debt repayment) support the rating. As a result of cost control initiatives and disciplined sales general and administrative (SG&A) management in addition to very lean inventory positions, the company was able to limit gross margin declines to less than 300 basis points (bps) in 2020 and generated approximately $130 million of cash from operations with a substantial portion coming from working capital benefits. As a result, the company paid down about $190 million outstanding on its revolver during fiscal 2020 while keeping meaningful balance sheet cash to offset any short-term headwind the company could face. For fiscal 2021, we expect the company to generate free operating cash flow of about $80 million on a sustained basis due to working capital investments normalizing which we expect will be directed towards dividends, share repurchases and paydown of revolver borrowings.
“Industry headwinds persist in the Footwear apparel retail segment while the company remains prone to merchandise missteps. Our rating incorporates our view that the company remains vulnerable to changes in consumer discretionary spending and fashion risks. Given the fierce competition at the FF apparel retail segment–including from new online players and the tough industry dynamics, execution misses on product assortments could pressure earnings and deteriorate credit metrics more than we envision. Our rating also reflects the company’s small-scale and significant merchandise sourcing exposure to China (which amounts to about 60 percent pre-pandemic). The company’s Brand Portfolio segment relies on wholesale partners and carries mostly dress and formal footwear. In 2020, it suffered from the ongoing pandemic-related effects and dampened wholesale performance with a 32 percent decline in revenue in the fourth quarter, including declines at the Allen Edmonds brand. We expect the shift in consumer preferences toward wellness, comfort, and sport categories will likely continue in the near term and Brand Portfolio to continue to experience sales declines in the high 20 percent area in the first half of 2021, with a slow recovery in the second half of the year.
“The stable outlook reflects our expectation that Caleres will continue to improve its operations over the next 12 months driven by positive top-line and earnings trends at its Famous Footwear segment, leading to leverage improving to the mid-to-high-3x area over the next year. We expect the Brand Portfolio segment’s performance to gradually become more stable in the second half of 2021 as consumer demand for dress and formal footwear remains challenged and that the company will continue to demonstrate a balanced financial policy.”
Photo courtesy Caleres