Wahoo Fitness’ debt ratings were downgraded by Moody’s and S&P Global Ratings due to weaker than expected demand and intense price competition in the at-home fitness space.
Moody’s lowered its rating on Wahoo Fitness Acquisition L.L.C., including its Corporate Family Rating (CFR) to B3 from B2, its Probability of Default Rating (PDR) to B3-PD from B2-PD, and the rating on the company’s senior secured first-lien credit facility to B3 from B2. The first-lien credit facility consists of a $30 million first-lien revolver due 2026, and a $225 million original principal amount first-lien term loan due 2028. The outlook is negative.
Moody’s wrote, “Today’s downgrade and negative outlook reflect Moody’s expectations that Wahoo’s debt/EBITDA leverage will materially increase in fiscal 2022 and that liquidity is constrained due to lower revenue and earnings than Moody’s previous expectations. Wahoo generated strong year-over-year revenue growth of 38 percent in fiscal 2021 that was driven by strong consumer demand for the company’s products. However, Moody’s believes 2021 earnings were bolstered by pandemic-driven demand for at-home fitness products and higher channel inventories, and thus this earnings level does not appear sustainable. Wahoo is experiencing a drop in sales of its trainer products during the start of fiscal 2022. The sales weakness is driven by channel de-stocking due to high inventory levels of trainers at retail at the end of 2021, heavy discounting of competitive products, as well as a return to more normal seasonality relative to un-seasonally large sales in the first quarter of 2021. As a result, Moody’s projects Wahoo’s revenue to decline in the mid-teens percentage and a meaningful decline in EBITDA of around 45 percent in fiscal 2022. Wahoo’s debt/EBITDA leverage is expected to increase to 5.5x in fiscal 2022, up from 3.1x at the end of fiscal 2021. Moody’s expects that debt/EBITDA leverage will be significantly higher during the second and third quarter periods of 2022, due to business seasonality.
“Wahoo’s liquidity will be constrained over the next 12 months by Moody’s expectations of negative free cash flow of around $30-$35 million and high reliance on its $30 million revolver facility. Free cash flow will be pressured by significant investment in working capital, primarily in inventory to support new product launches and refreshes in 2022. Moody’s projects Wahoo will rely on revolver borrowings over the next few quarters to fund the investments in inventory. Given the expected drop in profitability, Moody’s expects the company will not be in compliance with the first lien credit facility financial maintenance covenant of maximum total net leverage of 5.0x, particularly during the second and third quarter periods ahead of the winter selling season. To address its constrained liquidity, Wahoo announced a proposed amendment to the first lien credit facility that will waive the financial maintenance covenant through the third quarter of fiscal 2022 and replace it with a $5 million minimum liquidity covenant. Starting in the fourth quarter of 2022, the covenant test will be reinstated at 7x, step down to 5.5x in the first quarter of 2023, and finally step down to 5.0x in the fourth quarter of 2023 and thereafter. Moody’s believes the proposed amendment will alleviate Wahoo’s covenant compliance concerns and provides some financial flexibility over the next 12 months. In addition, the company received an approximately $12 million equity co-investment from a new board member that is expected to provide near-term cash liquidity.
“Wahoo has a good record of successful new product launches and it expects significant sales and earnings contribution from several new products and refreshes in late 2022. However, there is uncertainty regarding the sustainability of consumer demand for the company’s products. Demand could moderate or turn negative as ongoing inflationary pressures are starting to erode consumer spending power, and as consumers shift spending back to categories that were limited over the past few years such as travel. There is also uncertainty regarding macro-economic conditions, particularly in Europe, the company’s largest market, and ongoing supply chain challenges could also pressure profitability if the company is unable to mitigate cost inflation.”
S&P downgraded its issuer credit rating on Wahoo to ‘B-‘ from ‘B’. At the same time, it lowered its issue-level rating on its senior secured credit facilities to ‘B’ from ‘B+’. The recovery rating remains ‘2’, indicating its expectations for substantial (70 percent-90 percent; rounded estimate: 70 percent) recovery in the event of a payment default.
The negative outlook reflects the potential for a lower rating over the next year.
S&P wrote in its analysis, “The downgrade reflects weak operating conditions and our expectation for a material decline in the company’s earnings in 2022, which will weaken credit metrics. Wahoo’s revenue increased significantly in the first half of fiscal 2021, driven by strong end-user customer demand along with tight supply chain conditions at the end of 2020. Its channel partners thus entered 2021 with substantially lower inventory on hand. However, end-user customer demand fell well below expectations in the second half of 2021, resulting in an over-stocked channel by year-end. Additionally, the company faces intense competition from larger competitors such as Garmin and, to a lesser extent, Peloton, who are engaging in aggressive promotional activity to sell down excess channel inventory. We understand Wahoo has not engaged in such promotions because it expects these discounts to be temporary and has better brand equity to sustain higher prices.
“Further, the company is vulnerable to economic cycles given the discretionary nature of its products. We recognize the unique nature of Wahoo’s loyal customer base and expect that in a downturn many would reduce discretionary spending in other areas before cutting back on cycling-related purchases. Nevertheless, we believe a large segment of customers would defer purchases of product upgrades in a recessionary and/or inflationary environment which is increasingly likely.
“Therefore, we project revenue would drop about 20 percent and S&P Global Ratings-adjusted EBITDA about 30 percent in fiscal 2022, resulting in elevated leverage of about 5.5x. Sales and profits stabilizing at these levels would likely be sufficient to maintain the rating. However, we note the risk that a portion of the high demand in early 2021 may turn out to be a one-off, with significant uncertainty remaining on where normalized demand for indoor bike trainers and accessories would settle following the COVID-19 pandemic.
“Driven by weak industry dynamics and the highly seasonal nature of the business, Wahoo is at risk of breaching its quarterly financial net leverage covenant and has launched an amendment to its credit agreement, including a covenant waiver and tighter restricted payments. Typically, the company’s sales are concentrated in the back half of the year (about 65 percent of total revenue), which coincides with colder months in the Northern Hemisphere and the holiday season. However, Wahoo reported an unseasonably weaker second half in fiscal 2021 and projects a seasonably weak first half of fiscal 2022. This will result in weak last-12-months EBITDA and a breach of the covenant if not waived or loosened. We expect the company to obtain a covenant waiver from its lender group. Nevertheless, it is important to note that Wahoo believes point-of-sale demand for its products remains strong (certain large retail partners have reported double-digit percent sales growth in the first two months of 2022) and that its sales should rebound after oversupply in the channel is resolved.
“We forecast Wahoo’s margins will contract through fiscal year 2022 due to cost inflation. The company is facing higher commodity prices and freight costs. We understand Wahoo is evaluating price changes to offset higher costs. However, this may be insufficient to account for the increasingly inflationary environment. We expect margins will remain pressured for the next year.
“The negative outlook on Wahoo reflects the ongoing operational hurdles related to weaker than expected demand, intense price competition, and increasing cost pressures. If the company’s cash flow and liquidity position deteriorate further in 2022, it could add significant uncertainty to its ability to maintain a sustainable capital structure.”
Photo courtesy Wahoo Fitness