S&P Global Ratings affirmed its ‘CCC+’ issuer credit rating on Varsity Brands and revised the outlook to stable from negative.
S&P said the outlook revision reflects Varsity Brands’ improved performance in recent months as its businesses continue to recover from the pandemic.
S&P said in a statement, “After dramatic sales declines through the first quarter of 2021, the company had a strong second quarter with sales increasing close to 90 percent year-over-year. While this figure is somewhat inflated because of timing issues (cheerleading competitions usually held in the first quarter were delayed to the second quarter, and fall and winter sports were played in the spring in some regions), order rates for the team sports segment (BSN Sports, over half of the business) continue at about 20 percent above 2019 orders. The company’s cheerleading (Varsity Spirit) and scholastic achievement (Herff Jones) businesses remain depressed compared to 2019, but we expect moderate improvement over the next year as schools transition from virtual to in-person learning. We forecast Varsity Brands’ consolidated fiscal 2021 sales and profits will be down about 10 percent from fiscal 2019. While we do not expect the company to fully restore organic revenue until 2023, our forecast incorporates permanent cost savings from management initiatives (including centralizing administrative functions and rationalizing procurement spend) to help drive profitability in 2022 ahead of 2019. Still, we expect weak credit metrics, with leverage improving to the mid-8x area at the end of fiscal 2022 from about 10x at the end of fiscal 2021.
“Notwithstanding recently improving trends, unfavorable coronavirus developments could slow the company’s path to recovery. The Delta Variant and potential other virus mutations pose a risk to our forecast. Our base-case forecast assumes schools move forward with reopening plans in the fall and resume sport seasons as regularly scheduled. But demand for all of Varsity Brands’ products would weaken if COVID-19 infection rates rise substantially (particularly among children) and school reopening plans and sports seasons are again postponed. Global supply chain disruptions could also modestly dampen BSN Sports’ solid near-term growth prospects. While order rates have been strong, the company may have difficulty fulfilling them because of global shipping bottlenecks, which hinder its ability to import containers of apparel and other merchandise. We expect higher freight rates and commodity costs could also modestly pressure margins, though we expect Varsity Brands will partly offset these costs with price increases.
“The potential long-term effects of the pandemic on the cheerleading and scholastic achievement businesses remain a relative unknown. With Varsity Spirit and Herff Jones still trending well below 2019, we are uncertain whether the virus will have more lasting negative effects. Orders for cheerleading apparel remain about 15 percent below 2019, which may only reflect a short-term impact from the virus. But there is also potential for a shift in sector dynamics, including lower long-term participation rates or a more intense competitive landscape in an industry the company has historically dominated.
“School contract signings for yearbooks are also depressed, and pre-pandemic demand may not return. The lower contract signings could be attributable to delays as schools focus on reopening, but yearbook demand was already softening prior to the pandemic, partly because the company’s target consumer is increasingly digitally focused. The pandemic could further accelerate this trend. Our forecast assumes revenue from these businesses remains lower than 2019 over the next couple of years, but we will not have a clearer view of the long-term outlook until the environment normalizes. We do expect, however, continued recovery in demand for graduation caps and gowns.
“Leverage will likely remain elevated for the long term given management’s appetite for acquisitions. Despite still very high leverage, management will likely resume its active acquisition strategy given its adequate liquidity. While we expect most merger and acquisition (M&A) activity will center around small roll-ups of local dealers to complement BSN Sports’ business, we believe the company’s aggressive strategy will likely cause leverage to be sustained at very high levels over the next few years even if the business fully recovers.
“Our ratings assume no material unfavorable litigation outcomes. Certain of Varsity Brands’ subsidiaries are defendants in three class-action lawsuits alleging it monopolizes the nationwide cheerleading competition and apparel markets. One case alleges that the company controls 80 percent of the competition market, 80 percent of the apparel market and 75 percent of the camp market, as well as the industry’s major rulemaking organizations, USA Cheer and the U.S. All Star Federation. Among anticompetitive behaviors alleged in the lawsuits are that the company increased prices on cheerleading events after acquiring its largest competitors and forced teams to stay at company-approved hotels to participate in competitions. The plaintiffs seek monetary damages, restrictions against the company’s alleged anti-competitive control, and a breakup of the industry, including the rulemaking organizations. Separately, a civil negligence case was filed in connection with the alleged criminal conduct of an individual previously affiliated with the company. We do not believe the cases have reached the trial stage. Our base-case forecast assumes no adverse outcomes that would impair the company’s business or credit metrics, though it’s a risk.
“Our stable outlook on Varsity Brands reflects our expectation for a solid operating performance from BSN Sports and slower recovery from Varsity Spirit and Herff Jones, resulting in improved, albeit still very weak, credit metrics. This includes leverage improving to the mid-8x area and EBITDA interest coverage in the mid-1x area in fiscal 2022. We expect the company will maintain adequate liquidity as it continues its path toward full recovery. We also assume no unfavorable litigation developments that would materially affect the company’s credit metrics or competitive position.”
Photo courtesy Varsity Brands
