CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'BBB-' Issuer Default Rating (IDR) for The Gap, Inc. (Gap). The Rating Outlook is Stable. The company had $1.35 billion of debt outstanding at fiscal year-end May 2, 2015. A full list of ratings follows at the end of this release.
KEY RATING DRIVERS
The ratings incorporate Gap's flat to modestly negative annual comparable store sales (comps) growth over the near to intermediate term, Gap's reasonable credit metrics and consistently strong free cash flow after dividends (FCF).
The company has mature businesses in North America, faces declining mall traffic and has had merchandising/execution issues which have resulted in erratic comp performance at one or more of its major brands over the past few years. This has been offset in part by growth in its online business, emerging markets and newer retail concepts. As a result, Fitch expects consolidated comps to be flat to modestly negative over the intermediate term.
Gap's consolidated comps were flat in 2014 following a 2% increase in 2013. This was driven by a -5% comp at the Gap branded business, a flat comp at Banana Republic, and a +5% comp at Old Navy.
The Gap brand, which accounted for 38% of the company's 2014 sales, is experiencing weak sales trends driven by problems with its women's apparel assortment. New management will need to correct these merchandise issues, but it will take several quarters given long sourcing lead times to get some visibility into their ability to turn around negative sales trends. Banana Republic accounted for 18% of 2014 sales and is also experiencing weak comp sales that will take time to reverse under new management.
The bright spot has been Old Navy, which accounted for 41% of 2014 sales, and has generated positive comps for the past three years (6%, 2% and 5% in 2012, 2013, and 2014 respectively). In addition, Gap's online business, which accounted for 15% of 2014's sales, has supported its consolidated results, growing 11% in 2014 following healthy 21% growth in 2013, providing a 1.6% boost to consolidated comp sales.
Fitch expects consolidated comp sales to be negative 1%-2% in 2015, driven by mid to high single digit growth in online sales and modestly negative store level comps.
Top-line sales will also be driven by square footage growth of around 2.5% in 2015, as the company continues to expand its footprint following square footage declines from 2008-2012. Expansion is focused in Asia and emerging markets, with the planned addition of 40 new stores in China, and continued growth of Old Navy in Japan, as well as 20 new Athleta stores in the U.S. Fitch expects Gap will continue to grow its square footage at a low single digit pace going forward.
Gap's gross margin rate declined by 70bps (basis points) during 2014, reflecting weaker performance at the Gap brand and the effect of the stronger dollar. This, together with a slight deleveraging of the SG&A ratio, resulted in a contraction in the EBIT margin to 13.3% from 14.0 in 2013. With continued operating weakness at the Gap brand and ongoing currency headwinds, Fitch expects the EBIT margins will narrow further to the low to mid 12% range in 2015. However, EBITDA is expected to remain fairly stable at or near $2.6 billion.
Fitch expects leverage (adjusted debt/EBITDAR) to be relatively stable in the 3.1x range in 2015 and beyond, as growth in EBITDA beyond 2015 is expected to offset the impact of higher rent expense from international expansion (Fitch capitalizes rent at 8x).
LIQUIDITY
Gap has maintained solid liquidity, with an unused $500 million revolver and cash and cash equivalents of $1.2 billion as of May 2, 2015. The company generated solid FCF after dividends of $1 billion in 2014 and Fitch expects FCF to range from $600 - $700 million annually over the next two years. Fitch expects FCF to be directed towards share repurchases.
The company may also use some of its excess balance sheet cash for share repurchases, but is nonetheless expected to retain sufficient cash to handle its seasonal working capital needs without having to tap its $500 million revolver.
KEY ASSUMPTIONS
--Comp sales that are negative 1%-2% in 2015, and flat to modestly negative in 2016-2018. Assuming a roughly 1.5% contribution to the comp from online growth, this implies low single digit negative store-level comps.
--EBIT margin declines from 13.3% in 2014 to low to mid-12% range in 2015, reflecting gross margin pressure and some expense deleveraging, and is relatively steady thereafter.
--EBITDA that relatively steady at around $2.6 billion - $2.7 billion annually.
--FCF of $600 - $700 million over the next two years will be directed to share repurchases.
--Adjusted leverage is flat at around 3.1x over the next three years.
RATING SENSITIVITIES
Future developments that may, individually or collectively, lead to a positive rating action include an extended period of comps in the positive 2% range, sustained margin improvement, the maintenance of more conservative financial policies, and improvement in adjusted leverage toward the mid-to-high 2x range.
Future developments that may, individually or collectively, lead to a negative rating action include sustained negative comps that lead to EBITDA deterioration in the $2.3 billion range or a more aggressive financial posture, that would increase adjusted leverage toward the mid 3x range.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
The Gap, Inc.
--IDR at 'BBB-';
--$500 million senior unsecured revolving credit facility at 'BBB-';
--Senior unsecured notes at 'BBB-'.
The Rating Outlook is Stable.
Additional information is available on www.fitchratings.com
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 28, 2014).
Applicable Criteria
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage [749393 - 28-MAY-2014] (pub. 28 May 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
Additional Disclosures
Solicitation Status
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