S&P Global Ratings lowered its issue-level ratings on VF’s unsecured debt due to the debt being taken on from its pending acquisition of Supreme.
S&P lowered its long-term issuer credit rating on VF to ‘A-‘ from ‘A’ and short-term rating to ‘A-2’ from ‘A-1’. Concurrently, it reduced its issue-level ratings on VF’s unsecured debt to ‘A-‘ and removed all ratings from CreditWatch where they were placed with negative implications on Nov. 9, 2020.
VF in mid-November entered into a definitive agreement to acquire streetwear company Supreme for $2.1 billion cash (excluding potential earn-out payments). VF plans to fund the transaction using some proceeds from senior notes it issued in April, along with commercial paper borrowings. S&P noted that VF’s leverage was already elevated because of the EBITDA decline related to the COVID-19 pandemic fallout. The acquisition will increase VF’s leverage and extend the timeline to reduce back to pre-pandemic leverage.
S&P wrote in its analysis, “The downgrade reflects our forecast that leverage will stay above 2x for a prolonged period, resulting in higher financial risk. We forecast VF’s acquisition of Supreme will keep leverage above 2x until at least fiscal 2023 (ending March 2023). In our view, the incremental financial risk associated with operating with higher leverage for such a prolonged period offsets the strategic benefits of the acquisition.
“VF’s net leverage was in the low-3x area as of its fiscal second quarter ended in September, primarily because of the temporary closures of VF’s stores and those of its retail customers because of pandemic-related mandates. The company performed better than expected in its second quarter, but revenue was still down about 18% year over year. Although we already expected VF’s leverage would be temporarily well above our 2x downgrade threshold for the ‘A’ rating, we believed the company could improve below 2x by the end of fiscal 2022, assuming a gradual return to pre-pandemic sales and EBITDA. However, the acquisition of Supreme will spike VF’s leverage even higher to about 4x in fiscal 2021. We forecast an improvement to the high-2x area in fiscal 2022 due to a rebound in consumer spending and the full-year contribution of Supreme, and further improvement to the low-2x area in fiscal 2023. However, it may not return below 2x, our downside threshold for VF at the ‘A’ rating, until 2024 or 2025.
“We believe the acquisition signals a modestly more aggressive financial policy. We understand VF intends to prioritize deleveraging to its long-term target of less than 2x. However, we believe the willingness to increase leverage above 4x to fund an acquisition during a pandemic when revenue is still declining represents a modestly less conservative financial policy than we previously thought. We expected in the past that leverage would occasionally rise modestly above 2x for certain acquisitions, but we assumed VF would reduce it back under 2x within 12-24 months, much quicker than the path we project following the Supreme acquisition.
“Supreme is a popular streetwear brand with high margins and good cash flow, but its revenue growth could be volatile. Supreme is arguably the most well-known streetwear brand globally, blending skate-influenced origins with luxury fashion. Its business model involves releasing limited quantities of new items in weekly drops, which drives much of its success. It regularly collaborates with other streetwear and fashion brands such as Louis Vuitton and Nike, as well as VF’s Vans, The North Face, and Timberland. Supreme has a strong digital presence, achieving good margins and cash flow over the past several years. Supreme has only 12 retail stores, so we believe there is an opportunity to expand its presence, especially internationally. It may also benefit from VF’s large and well-developed supply chain and digital platform.
“However, we have some doubts about the company’s ability to maintain sales growth anywhere near the rapid pace of the past few years. The model relies on exclusivity and scarcity, so increasing distribution without diluting the brand will likely be an ongoing challenge. We expect periods of good sales growth because Supreme has a large base of devoted customers and tailwinds from streetwear’s continued popularity. However, revenue and profitability could be relatively volatile over time.
“The stable outlook reflects our forecast that VF will prioritize deleveraging over the next two years to the high-2x area in fiscal 2022 and the low-2x area in fiscal 2023. We expect VF will benefit from a healthy recovery in consumer spending in 2021 and that consumer trends will continue to favor outdoor, active, and casual apparel.”
Logo courtesy VF/Supreme
