Foot Locker Gets Credit Rating Lowered To Junk

This afternoon S&P Global Ratings downgraded both Foot Locker’s issuer credit rating and issue-level rating on the company’s senior unsecured notes from “BB+” to “BB.” This means the apparel and footwear retailer’s credit risk and notes have gone from being investment grade to speculative, or, in Wall Street parlance, “junk.”

Three weeks ago Foot Locker’s shares plunged when it reported falling sales and profits and cut its outlook for the full year. At that time, Mary Dillon, President and Chief Executive Officer of Foot Locker, said in a press release, “Our second quarter was broadly in line with our expectations, despite the still-tough consumer backdrop. However, we did see a softening in trends in July and are adjusting our 2023 outlook to allow us to best compete for price-sensitive consumers, while still leaning into the strategic investments that drive our Lace Up plan. Importantly, we are continuing to make progress on our inventory levels and look to best position the business for the upcoming holiday season and into 2024.”

Over the past month shares of Foot Locker have been battered even worse, falling from $25 to $19.

Among the reason for the credit downgrade cited by S&P Global: a free operating cash flow deficit of approximately $120 million this year and increased S&P Global Ratings-adjusted leverage to 2.9x for fiscal 2023.

The S&P Global release says: “The negative outlook reflects the risk that operating performance could remain challenged amid a soft operating environment, along with execution risks related to Foot Locker’s operating initiatives….We project total sales to be down roughly 9% in fiscal 2023 as Foot Locker continues to navigate through its Nike
NKE
reset and repositioning of its Champs banner, combined with lower than expected return-to-school sales volume. “

Nike and Foot Locker had had a long-running feud that has hurt both companies. In July it was reported that the two companies might be headed for a truce. But apparently not soon enough.

For the second quarter, Foot locker’s inventory was 11% above the prior-year period, a material improvement from the first quarter, which was roughly 25% above the prior-year period. S&P anticipates the Foot Locker will remain promotional, allowing it to further reduce elevated inventory and partially mitigate weaker customer traffic trends.

As a result, Foot Locker’s margins will get squeezed. S&P Global says the company’s EBITDA margins declined roughly 400 basis points in the second quarter of 2023 toward the mid-14% area, compared to the mid-18% area in the prior-year period. Says the ratings agency: “We attribute this primarily to aggressive markdowns as Foot Locker continued to reduce its excess inventory. We forecast adjusted EBITDA margins will contract further toward the high-12% area for fiscal 2023 as continued promotional activity, increased occupancy costs, and ongoing retail shrinkage pressure profitability. “

Foot Locker has no near-term debt maturities, with an asset-based lending facility maturing in 2025 and $400 million of senior unsecured notes maturing in 2029. S&P Global anticipates Foot Locker’s debt balances will be largely unchanged over the next 12 months.

Finally, S&P Global says: The negative outlook reflects the heightened risk that Foot Locker will not stabilize operating performance and improve cash flow generation over the next 12 months, which could lead us to downgrade the company further over that timeframe.”