LONDON (Alliance News) - S&P Global Ratings downgraded Debenhams PLC credit rating to B+ from BB- on Wednesday whilst also retaining a Negative outlook for the department store chain as "extreme" competitive environment and an "ambitious" turnaround strategy pressure results.
"The downgrade reflects our view that, despite signs of improvement in the second half of the year, overall trading conditions for discretionary goods retailers in the UK will remain extremely challenging in 2018," S&P Credit Analyst James Holkham-Coates said. "Debenhams' recently reported further declines in like-for-like sales and profitability margins have led to credit metrics that are materially weaker than in our previous base case."
S&P feared that despite cutting its dividend and expansionary capital expenditure to retain cash, it would still not generate enough funds to cover its dividend. This will also, in turn, reduce its ability to reduce leverage from its already "elevated" levels and "lessen its ability to withstand additional operating setbacks."
Earlier in April, Debenhams cut its interim dividend by 51% to 0.50 pence per share from 1.025p the year before.
"We expect current conditions to pose the greatest challenge for retailers - such as Debenhams - with high operational gearing on account of large store estates and substantial associated fixed rental expenses,S&P explained. "Although macroeconomic conditions in the UK are proving more resilient than we previously expected - driven by slowing inflation and a robust labour market - we expect declining real wages and footfall in the first half of the year will weigh on discretionary goods retailers' toplines and margins as they compete to maintain their share of a smaller consumer wallet."
S&P's decision to also retain a Negative outlook on Debenhams was a result of the "extreme competitive pressures" it is facing. These pressures combined with its "Redesigned" strategy will continue to pressure cash flow at the firm, S&P argue.
The credit analyst believed the "ambitious" Redesigned project will result in negative free cash flow and lead to leverage rising above 7.0 times earnings before interest, tax, depreciation and amortisation.
The benefits of this project, however, would "take time to bear fruit" and would require substantial capital expenditure due to the size of its store estate.
In April 2017, Debenhams announced it had identified 10 stores at risk of closure. This was after they were deemed as likely to become unprofitable over time. It was also looking to downsize another 30 and refurbish several others.
S&P did highlight the benefits of its online operations - which grew 9.7% in the first half of financial 2018 - were a positive for the credit rating of the firm but with a significant caveat.
"We still view the group's growing multi-channel capabilities and own brand products as key mitigating factors to the risk of product substitution posed by online competitors," S&P said. "That said, we continue to expect the group's e-commerce revenues to grow at a slower pace than online-only players such as Asos and Zalando. As such, we expect that like-for-like declines at physical stores will continue to more than offset any near-term further improvements to the group's e-commerce revenues."
In financial 2018, S&P expected adjusted Ebitda to be between GBP350 million and GBP370 million compared to the GBP400 million in 2017. This, however, S&P expects to increase to GBP380 million to GBP400 million in financial 2019.
Shares in Debenhams were 1.0% higher at 23.38 pence on Friday.
