S&P Global Ratings revised the debt ratings outlook on Nordstrom to stable from negative, reflecting its belief that the retailer will demonstrate a sequential recovery in operating performance this year, generating more than $1 billion in operating cash flow.
The outlook change comes as Nordstrom announced it is issuing $675 million of new senior unsecured notes and intends to use the proceeds to redeem its $600 million 8.75 percent senior secured notes due 2025, fund the make-whole premium as well as pay fees and expenses.
S&P assigned its ‘BB+’ issue-level rating to the proposed senior unsecured note offerings. The recovery rating is ‘3’, indicating its expectations for meaningful (50 percent to 70 percent; 65 percent rounded estimate) recovery in the event of default. S&P said it would withdraw its ratings on the secured notes after they are repaid.
Concurrently, S&P revised its recovery rating on Nordstrom’s existing senior unsecured debt to ‘3’ from ‘4’. The ‘BB+’ issue-level rating is unchanged. S&P affirmed all of its ratings, including the ‘BB+’ issuer credit rating.
S&P wrote in its analysis, “The stable outlook reflects our expectation for a sequential recovery in operating performance and gross debt reduction this year, resulting in S&P Global Ratings-adjusted leverage improving to below 3x by fiscal year-end 2021. Sales trends at Nordstrom have sequentially improved since stores reopened last year, and we expect results to recover at an accelerating pace as restrictions ease, consumer confidence builds, and the economy reopens. Further, we believe the company’s strategic initiatives to expand its merchandise, broaden its customer reach, and enhance its digital capabilities can serve as additional levers to recoup sales lost during the pandemic. Net sales declined approximately 32 percent in 2020, trailing peers in both the full-line and off-price segments, and the challenging forces of the pandemic contributed to a net operating loss of more than $1 billion. However, in response to COVID-19-related pressures, the company implemented material cost reductions, including approximately $300 million of annualized permanent overhead savings. We believe this lower fixed-cost base will support earnings generation at lower sales volumes. For 2021, we estimate Nordstrom will generate adjusted EBITDA that approaches 80 percent of 2019 levels, achieved by strengthening sales volumes to recover from COVID-19 progress. We expect improving operating cash flow generation, coupled with a sizable cash tax refund, will position the company to repay its $500 million bond maturing in October, facilitating its ability to reduce adjusted leverage to below 3x this year.
“We believe Nordstrom will benefit from a recovery in apparel spending as consumers refresh their wardrobes throughout the year and easing restrictions support a return to in-person shopping. The company’s Market Strategy, which enables inventory visibility across its digital and physical footprint, has shortened fulfillment times, increased product availability, and increased customer engagement. We expect the company will drive sales growth as these capabilities are added to new markets this year. We also expect Nordstrom will continue to leverage its leading omnichannel capabilities to defend its market share. The company grew digital sales approximately 16 percent year-over-year in fiscal 2020, representing 55 percent of total sales, up from 33 percent at fiscal year-end 2019.
“Still, our longer-term view is that changing consumer preferences will be difficult to navigate. Declining mall traffic, shifting category preferences, and online price transparency are persistent risks that will continue to challenge Nordstrom’s full-price business. Nordstrom is expanding its product assortment by evolving its business model to rely less on its traditional wholesale channel and expanding the use of revenue sharing, drop shipping, and concessions. We believe there are benefits to this approach, including greater merchandise selection, less inventory risk, and reduced working capital needs, but the company will need to navigate execution issues and drive higher volumes to offset what we believe to be lower margin models.
“Strengthening Nordstrom Rack’s value proposition will be key to achieving management’s long-term sales growth targets. Nordstrom Rack, the company’s off-price business, has traditionally focused on serving fashion-forward, brand-oriented customers. This customer segment is narrowing as growth trends illustrate consumers are embracing either deep discounts or luxury products, with the middle-tier squeezed.
Sales at Nordstrom Rack declined 35 percent last year, continuing a multi-year trend of underperforming off-price peers. In response, the company is repositioning its stores to target different customer segments based on market demographics. To date, the company has reconfigured the merchandise and layout of approximately 30 percent of its stores. It believes, if executed successfully, this could enable Nordstrom Rack to compete more effectively for price-oriented customers and expand its addressable market. Still, the repositioning pushes the company deeper into the discount space, which is highly competitive and crowded with many sharp operators.
“The company accelerated its digital strategies within Nordstrom Rack last year, adding in-store fulfillment, ship to store and cross-banner returns. While we expect brick & mortar sales to contribute the majority of off-price industry revenue due to the difficulty of replicating the in-store treasure hunt experience, Nordstrom Rack’s omnichannel capabilities give it an edge to be a digital leader in this segment. This still requires the company to have the right product assortment at the right price to resonate with customers and win back the share that it has ceded in recent years. Further, Rack’s digital business’s contribution margin is inferior to in-store sales, and the company will need to drive scale and efficiencies to improve profitability.
“Recovering business performance and anticipated debt reduction later this year will strengthen credit metrics. Today, Nordstrom launched a refinancing transaction that seeks to redeem the 8.75 percent $600 million secured notes the company issued last year. The transaction will unencumber the properties pledged to the secured notes, extend Nordstrom’s maturity profile, and reduce annual cash interest expense. The two-part offering, consisting of a $250 million three-year note and a longer duration $425 million 10-year note, is slightly leveraging as the make-whole premium of the secured notes is rolled into the new issuance. However, we forecast improving cash generation during the year and expect Nordstrom will repay its $500 million unsecured notes maturing later this year with cash received from the company’s 2020 income tax refund. We believe the company’s liability management efforts, in conjunction with adjusted EBITDA recovering to between 75 percent-80 percent of 2019 levels and year-end cash balances of roughly $1 billion, will result in adjusted leverage improving below 3x by fiscal year-end. Based on our updated forecast, which projects adjusted leverage remaining below 3x, we are revising our financial risk profile assessment to intermediate from significant. We view the ‘BB+’ rating as accurately reflecting Nordstrom’s stand-alone credit risk profile and therefore are revising the comparable ratings analysis modifier to neutral from positive.
“The stable outlook reflects our expectation that improving operating performance and debt reduction later this year will result in adjusted leverage improving to below 3x by fiscal year-end. We expect an additional recovery in operating results in 2022 but at levels that remain well below pre-pandemic thresholds.”
Photo courtesy Nordstrom