On Jan. 27, 2020, S&P Global Ratings lowered its ratings on German beauty retailer Kirk Beauty One GmbH to B-/Stable/-- from B/Negative/-- because we expect the group's business transformation to continue amid challenging non-food retail markets, and we believe credit metrics will remain weaker than previously expected despite recently improving operating performance.
Kirk Beauty is a Germany-based holding company of Douglas Group, which is among the leading European specialist retailers of selective beauty and personal care products with annual revenue of €3.5 billion in fiscal 2019. Douglas has No. 1 and No. 2 market positions in most of its core markets--Germany, France, Italy, Poland, and the Netherlands--as well as a strong No. 3 position in Spain.
Frequently Asked Questions
Why the downgrade given Kirk Beauty's lower leverage in fiscal 2019 compared to 2018?
Lower one-off costs and a return to positive like-for-like sales growth has indeed resulted in deleveraging to 6.7x in fiscal 2019 from 7.9x in fiscal 2018. In 2018, when we revised the outlook to negative from stable, we said that the leverage metrics were temporarily out of line with the 'B' rating and that deleveraging toward 6.0x in the following year was necessary to maintain the rating. However, we've since considered the company's recent needs for further investment in its assortment of products and weaker underlying profitability.
In particular, free operating cash generation after capital spending (capex), interest, and rent payments is now materially lower compared to what we have observed and expected two years ago. Although historically we have observed a reported FOCF of about €50 million to €100 in fiscal 2016 and 2017, we only expect a slightly positive single-digit number for fiscal 2020 following materially negative FOCF during the last two years.
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What about the group's strategic repositioning?
We believe that the German beauty retail market in particular is undergoing a structural change resulting in margin pressure and that the mid-priced product segment is mostly impacted. Hence, we appreciate that Douglas has repositioned its assortment by including more luxury and exclusive products and introducing new private-label products on the low end of the price category. The group has also ramped up an impressive online offering with nearly 17% of group sales generated through online channels in fiscal 2019 (about 29% in Germany). We believe that the group has a competitive advantage to participate in the beauty segment's future growth, which we expect to be somewhat above the overall retail market average.
These factors support our expectation that group sales will grow about 4.5%-5.0% in fiscal 2020 despite selective store closures. At the same time, the group will continue to face competitive pressure from mainly pure online players that are more focused on gaining market share and have lower profitability expectations and sometimes smaller-scale operations. We believe this will limit the group's margins and reported FOCF in fiscal 2020. In addition, further investment needs in the ongoing business transformation to an omni-channel retailer could constrain margins and cash flows further. We believe continued investments in online channels is particularly important for retailers to defend their long-term market positions against Amazon, which already has a 40% market share in the overall German non-store retail market.
How have you considered Kirk Beauty's bullet maturities in 2022 and 2023?
Kirk Beauty's capital structure will mature in 2022 and 2023. The currently undrawn revolving credit facility matures in February 2022 and remaining secured debt in July 2022, while the unsecured notes mature a year later in July 2023. In our liquidity calculation, we have only included revolving credit facilities that have at least 12 months remaining to maturity as a source of cash. We expect Kirk Beauty to successfully refinance the 2022 maturity over the next few quarters, which supports the stable outlook at the current rating level. We have not incorporated any material refinancing risks in our most recent rating action.
We believe that the company's improving operating performance trends, with better sales growth following the strategic repositioning, and our expectation of lower one-off costs in fiscal 2020 compared to 2019 should support a successful extension of the maturity profile over the coming quarters. At the same time, the group now has lower headroom for further underperformance because leverage is high and FOCF only marginally positive. Significant underperformance could jeopardize refinancing of these instruments, in our view.
How does Kirk Beauty compare with other 'B' and 'B-' rated European retailers?
Within our rated European retail portfolio, 'B' rated issuers:
- Either show leverage metrics according to S&P Global Ratings' adjusted basis in the 5.0x-6.0x range, and not higher than 6.0x, over the next two forecast years, as is the case for Iceland Topco, THOM Europe, Mobilux 2, and PrestigeBidco; or
- Exhibit materially positive reported FOCF generation if expected leverage is higher, which is the case for Picard Groupe, CD&R Firefly, and EG Group, for instance.
At the same time, European retailers that we currently rate 'B-', such as L1R HB Finance, Maxeda DIY Group, Missouri TopCo, The Hut Group, and Takko, have either leverage higher than 6.0x and/or, like Kirk Beauty, have very low or even negative expected reported FOCF without liquidity pressure over the first two years in the forecast period.
| European Retailers Rated 'B' and 'B-' | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Issuer | Rating | Busines risk profile | Financial risk profile | Anchor | Modifier | |||||||
| Kirk Beauty | B- | Fair | Highly leveraged | b | CRA: -1 notch | |||||||
| Thom Europe | B | Fair | Highly leveraged | b | N/A | |||||||
| Iceland | B | Fair | Highly leveraged | b | N/A | |||||||
| Picard | B | Fair | Highly leveraged | b | N/A | |||||||
| Mobilux 2 | B | Weak | Aggressive | b+ | CRA: -1 notch | |||||||
| PrestigeBdico | B | Weak | Highly leveraged | b | N/A | |||||||
| EG Group | B | Satisfactory | Highly leveraged | b+ | CRA: -1 notch | |||||||
| CD&R Firefly | B | Weak | Highly leveraged | b | N/A | |||||||
| L1r HB | B- | Weak | Highly leveraged | b- | N/A | |||||||
| Maxeda | B- | Weak | Highly leveraged | b- | N/A | |||||||
| Missouri | B- | Weak | Highly leveraged | b- | N/A | |||||||
| Takko | B- | Weak | Highly leveraged | b- | N/A | |||||||
| The Hut Group | B- (prelim) | Weak | Highly leveraged | b- | N/A | |||||||
| CRA--Comparable rating analysis. N/A--Not applicable. | ||||||||||||
Why did you reference a debt repurchase below par in the outlook?
S&P Global Ratings is not aware that management or the private equity owner of Kirk Beauty is planning a debt repurchase below par. However, our criteria on exchange offers state that in the case of a debt buyback below par, even if this is voluntary, S&P Global Ratings could view this as tantamount to a default if it were to see the offer as being distressed rather than opportunistic. For companies rated investment grade, we commonly regard these buybacks as opportunistic. For companies rated 'B-' or below, we often regard them as distressed and therefore tantamount to default. While this also depends on the circumstances, the combination of a low rating and debt trading has oftentimes suggested that investors accepted such an offer because they feared that they would have received even less otherwise.
We commonly refer to debt buybacks below par in our downside scenarios for 'B-' rated companies whose debt is currently or has recently traded below par. We also note that conventional financing documentation does not restrict companies or owners to repurchase debt below par nor does it constitute an event of default under such agreements. A recent example in the retail and restaurant sector is PizzaExpress, which conducted a buyback below par in December 2019, or House of Frasers, which conducted one in July 2018.
Related Research
- Research Update: German Retailer Kirk Beauty Downgraded To 'B-' On Weaker Credit Metrics Amid Ongoing Transformation; Outlook Stable, Jan. 27, 2020
- Research Update: Retailer Kirk Beauty Outlook Revised To Negative On Temporarily Reduced Earnings And Cash Flow; 'B' Rating Affirmed, Sept. 6, 2018
This report does not constitute a rating action.
| Primary Credit Analyst: | Patrick Janssen, Frankfurt (49) 69-33-999-175; patrick.janssen@spglobal.com |
| Secondary Contacts: | Mickael Vidal, Paris + 33 14 420 6658; mickael.vidal@spglobal.com |
| Raam Ratnam, CFA, CPA, London (44) 20-7176-7462; raam.ratnam@spglobal.com |
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