Moody’s Investors Service downgraded Foot Locker, Inc.’s debt ratings, reflecting Moody’s view that Foot Locker’s earnings and cash flow are likely to remain pressured for an extended period, given the execution risk associated with implementing its Lace Up plan transformation initiatives in a challenging consumer spending environment.

Ratings affected include Foot Locker’s)corporate family rating (CFR) to Ba2 from Ba1, probability of default rating (PDR) to Ba2-PD from Ba1-PD, and senior unsecured notes rating to Ba3 from Ba2, and maintained the negative outlook. The speculative grade liquidity rating remains unchanged at SGL-2.

Moody’s noted that comparable sales declined 9.4 percent with operating income margin below 1 percent in Q2 2023, and Moody’s projects further deterioration in the second half of 2023 driven by continued markdowns to lower elevated inventory levels and the annualized impact of reduced product allocation from Nike, Inc. Although Moody’s projects Foot Locker’s earnings to begin to recover in 2024 as the heavy promotional activity in the footwear sector moderates and the company’s cost savings and strategic initiatives generate more significant benefits, profitability is expected to remain well below historical levels. Moody’s views Foot Locker’s pause in dividend payments positively, as it will support its ability to generate modest free cash flow over the next 12-18 months while the company maintains a higher levels of capital expenditures.

Moody’s wrote in its analysis, “Foot Locker’s Ba2 CFR reflects the company’s scale and well-recognized Foot Locker brand, which has a strong position in the premium athletic footwear market in North America and Europe. The Foot Locker and Kids Foot Locker chains have a differentiated offering and provide a key distribution channel for vendors, particularly in the basketball, premium and kids categories. The rating also benefits from the company’s track record of maintaining a low level of funded debt relative to earnings. Moody’s expects adjusted debt/EBITDA to increase to 2.8x at year-end 2023 from 2.4x as of July 29, 2023, before improving to 2.7x in 2024. Interest coverage is projected to decline to 2.4x Moody’s-adjusted EBIT/interest expense in 2023 from 3.5x and improve towards 2.8x in 2024. Moody’s projects good liquidity over the next 12-18 months, with free cash flow turning positive in 2024 from a cash flow deficit in 2023, reflecting the pause in dividend payments and earnings improvement. The liquidity profile is also supported by access to the undrawn $600 million asset-based revolver and a covenant-lite capital structure.

“The rating is constrained by Foot Locker’s operations in the intensely competitive, fragmented and fashion-sensitive footwear sector, which faces pressure from the continued focus of brands on growing their direct-to-consumer sales. Foot Locker’s concentrated vendor base elevates the risk of further potential adverse changes in vendor relationships. The company is also exposed to declining mall traffic given its current store footprint and relatively limited digital penetration. Maintaining the value proposition of the Foot Locker and Foot Locker Kids businesses requires continuing to offer exclusive and high demand products to their core “sneakerhead” demographic. It also requires effective omnichannel investment to meet both consumer and vendor needs. In addition, the repositioning of the Champs Sports business carries elevated execution risk as it has a less differentiated position in the market and faces high competition.”