Rating Action Overview

• With operations in over 70 markets, Sweden-based H&M Hennes & Mauritz AB (H&M) is one of the world's largest and most well-known fashion retailers, with Swedish krona (SEK 187 billion (€17.9 billion) in revenue in 2020, the majority of which comes from the group's main H&M brand.
• While we anticipate continued COVID-19-related business disruptions until at least mid-2021, we believe H&M will likely deleverage to pre-pandemic levels, with S&P Global Ratings-adjusted debt to EBITDA of less than 2.0x in the next 12-18 months, and will maintain a strong balance sheet.
• We are assigning our 'BBB/A-2' issuer credit ratings to H&M.
• The stable outlook indicates our expectation that the group will achieve sales and earnings growth this year, and will further deleverage toward S&P Global Ratings-adjusted debt to EBITDA of 1.5x by fiscal 2022 while generating strong free operating cash flow (FOCF) after leases, which we forecast will exceed the dividend payments once these resume.

Rating Action Rationale

H&M is well positioned to sustain growth in the mostly saturated apparel retail markets in advanced economies such as Western Europe or North America.  Additionally, we still see growth potential in emerging markets such as Asia or Eastern Europe. In this respect, we note positively H&M's broad geographical earnings diversification across Asia and Eastern Europe (including Russia and Turkey), which represented about 11% and 13% of group sales during the first nine months in fiscal 2020 (ending Nov. 30, 2020), respectively. Germany, H&M's largest single-country contributor, only generated about 15.5% during the same period. Such diversification helps the group withstand any regionally isolated economic weaknesses and, coupled with its position as one of the most well-known brands in the fashion industry, puts H&M in a better position than most retail peers to participate in the different regional growth trends.

H&M faces intense competition in all markets, with earning relying on the success of its main H&M brand.  We expect competition in the industry will remain fierce, even more so for H&M given its focus on the mass-market section of the fast-fashion segment. We regard fast fashion as a more volatile industry segment given operators need to adapt collections quickly to changing consumer trends, and run the risk of not meeting consumer tastes, which could compromise their competitive standing. H&M holds a strong market position in many local markets, especially in European countries, but in many cases is not the largest local player. It faces strong competition from local and regional apparel retailers, as well as global players such as Spain-based market leader Inditex (Zara) and Japan-based Fast Retailing group (Uniqlo), which are comparable in scale with H&M. Despite H&M's recent strategy of diversifying its brand portfolio, and its success in increasing contribution to earnings from its more premium-end brand COS, we still consider H&M as a largely mono-brand retailer. The H&M brand represents about 88% of the group's store base as of Aug. 31, 2020, and contributes a similar level of earnings by our estimate. This brand concentration could result in earnings volatility should the company mismanage a fashion risk in a number of markets.

H&M is accelerating its online activities, but competition from established online players and brand manufacturers selling directly to end-consumers is intensifying. The expansion of e-commerce in the retail market has been one of the main secular trends in the retail industry over the last few years, with consumers spending more and purchasing a wider range of products online. This trend further accelerated in 2020 on the back of store opening restrictions related to the COVID-19 pandemic. We see the apparel category as particularly exposed to the impact of the changing landscape, given the online share of total sales in Europe, at about 20% according to Euromonitor, was already higher than the overall retail industry average in 2019. In this context, we view H&M's established online presence in all of its major markets (51 out of 74 total for the main H&M brand) as positive. The group's technology and logistics infrastructure, which was recently modernized in their largest online markets in Europe, positions H&M well to expand its customer base and sustain its earnings growth amid the accelerating e-commerce trend. At the same time, we note that H&M's online presence may not be as well developed across all of its markets, leaving room for other pure online and omni-channel players to challenge H&M's competitive position. The threat could come from omni-channel retailers with a stronger online presence such as Next in the U.K., pure online platforms such as Amazon, Zalando, or ASOS, or from branded apparel manufacturers reaching out to their customers directly or via online platforms. We acknowledge that the group made considerable progress by achieving about 26% of consolidated sales generated online in the first nine months of fiscal 2020. However, this is still lower than the 50% achieved by Next before the pandemic. At the same time, we note that H&M's online share is higher in the markets with higher e-commerce penetration such as Germany, the U.K., or Scandinavia, narrowing the gap to the industry leaders in these countries.

We consider that H&M's scale supports above-industry-average profitability, and shores up cash flow generation. With annual sales of about €18 billion in fiscal 2020, H&M is the largest non-food retailer we rate in Europe. The company's scale gives it particularly strong bargaining power with suppliers, the majority of which have maintained longstanding commercial relationship with H&M. This supports the group's profitability. With an expected S&P Global Ratings-adjusted EBITDA margin of about 17%-19% for fiscal 2022 following the phase out of the COVID-19 pandemic, H&M's profitability should return to above average levels in a comparison with specialty retailers in the next 12 months, after a temporary dip to less than 16% in fiscal 2020. In addition, H&M's ability to manage supplier terms and investments results in comparably strong cash generation for the business. While H&M leases almost all of its store base, we see its leasing contracts as flexible given their comparatively short-term break clauses and a comparably high share of turnover rents that we estimate were about one-third of annual lease expenses in 2019. This is particularly positive given current sales volatility and the increasing online trend.

H&M's historic margin development has been quite volatile, but we do not envisage any further deterioration.  Given the increasing share of online sales and associated share of variable costs and infrastructure investments, we think H&M is unlikely to reach its historical (2012-2016) EBITDA margin levels of 24%-29% in the foreseeable future. However, we think H&M will be able to curb the progressive margin erosion seen over 2016-2019 thanks to sustainable cost savings achieved during the pandemic. In our view, margin erosion prior to the pandemic largely stemmed from H&M's investments in their omni-channel operations, as well as some fashion missteps in some earlier collections. We also note that many apparel suppliers are located in Asia or Africa and payments are usually factored in U.S. dollar. At the same time the eurozone constitutes the largest single currency region of H&M'S operations (about 38% of group sales during the first nine months of fiscal 2020) adding to potential earnings volatility.

We expect H&M will continue to pursue its clear medium-term sustainability targets. We view positively H&M's advancement in reducing its carbon footprint, while increasing environmentally friendly apparel production and targeting the manufacturing of all its products through sustainable or fully recycled fabrics by 2030. We note that H&M was the first among large fashion retailers to set such an environmental, social, and governance target. We believe this positions the group well vis-a-vis the rising number of environmentally-conscious consumers, in an industry that is also subject to concerns regarding environmental sustainability and labor safety in low-wage countries. We believe the General Data Protection Regulation (GDPR)-related issue with regulators in Germany has been settled, and will likely result in a payment of about €35 million, which is substantially less than the possible 4% of annual sales. At the same time, we believe that the underlying policy breach by mistreating employees' personal data represents an isolated case that does not reflect a deficiency in the group's control mechanisms or management culture.

Despite material COVID-19-related business disruptions, H&M largely preserved its credit metrics and cash flows in fiscal 2020.  While sales declined by nearly 20% and S&P Global Ratings-adjusted EBITDA by about 35% in fiscal 2020 compared with the previous year, H&M's management took measures to support the balance sheet and averted a stronger decline in credit metrics, resulting in adjusted debt to EBTIDA of about 2.4x in fiscal 2020 (including capitalized lease obligations), compared with about 1.5x in the year before, which is only moderately out of line with our expectation for the current rating in fiscal 2020. Temporary government subsidies are available for markets in Europe affected by COVID-19, and will continue to help the fashion retailer during lockdowns. Furthermore, H&M made sustainable cost reductions. For example, throughout 2020, the group sustainably reduced its headcount and lowered its rental costs by renegotiating store leases with the landlords amid difficult real estate markets, taking advantage of its strong market position. These measures lightened H&M's fixed cost burden that we anticipate the group will sustain in the next two-to-three years. Moreover, working capital initiatives and cutting capital expenditure (capex) investments helped preserve cash generation and resulted in an S&P Global Ratings-adjusted free operating cash flow to debt of about 30% in fiscal 2020, which also supports our current assessment of H&M's financial risk as modest, despite current business disruptions.

Although we anticipate continued disruptions in fiscal 2021, we believe that H&M's credit metrics will strengthen again.  We believe H&M will expand its earnings and reduce debt over the course of fiscal 2021. This is because we assume that the pandemic and related restrictions on people movement will gradually ease from mid-2021, when extended immunization should help reduce the infection rate. We expect this will prompt policy makers to gradually relax lockdown measures, particularly in advanced economies in Western Europe and North America. If so, this will stimulate consumer demand and allow retail businesses to keep stores open. In addition, we expect H&M will contain its capex investments in light of some stores closures during part of fiscal year 2021, and will release working capital of Swedish krona (SEK) 8 billion-SEK10 billion over the next 12 months. Working capital efficiencies should stem from historically shorter-than-industry average supplier terms, the extension of which forms part of H&M's efficiency program and will likely be largely implemented in fiscal 2021. Alongside our expectation of H&M's return to shareholder remuneration in fiscal 2021, we believe that the company will deleverage to about 2.0x S&P Global Ratings-adjusted debt to EBITDA in fiscal 2021, and then to 1.5x in fiscal 2022.

Despite material uncertainties related to COVID-19, we believe the company's financial policy commitment and flexibility supports our 'BBB' rating.  We note that an extension of the pandemic could still jeopardize recovery prospects. While we assume that store-based non-food retailing in advanced markets will gradually emerge from the lockdowns in spring, and that the vaccines should effectively protect against virus mutations, we see risks associated with the timing and strength of demand recovery. Nevertheless, we believe that management's commitment to a healthy balance sheet will ensure return to shareholder remuneration only upon a higher certainty around the further development of the pandemic. We understand that, until then, H&M's management intends to maintain robust liquidity and a net cash position, which in turn should support the company's credit quality. In our view, this leaves flexibility to accommodate stronger-than-expected earnings headwinds and preserve credit metrics, as we have incorporated a dividend payment of about SEK12 billion in fiscal 2021 (for the year 2020). We understand, however, that H&M will only pay this dividend if it reaches its performance and capital structure targets.

Risk related to the pandemic, the acceleration of online shopping, and the industry's exposure to fashion risk result in above-average earnings risk for now.  For the fast-fashion industry, there is always a risk that collections won't match customer tastes. This exposes players to earnings shortfall risk, as for example, was the case with H&M's earnings and cash flow in fiscals 2017 and 2018. Teamed with the risks related to the pandemic, the rollout and effectiveness of vaccines, and increasing online competition amid the pandemic, we factor in the risk of potentially higher earnings and cash flow volatility for H&M compared with that for similarly rated peers in less discretionary industry segments. Relatively low headroom under the financial metrics over the next 24 months exacerbates this risk to the group's overall creditworthiness, in our view.

Outlook

The stable outlook reflects our expectation of still-depressed trading levels, albeit higher than those during the spring 2020 lockdown, until at least mid-2021. Under our base case, we assume the company will achieve positive year-over-year sales and earnings growth in fiscal 2021, deliver on working capital efficiencies, contain capex, and prioritize a strong balance sheet and solid liquidity over shareholder remuneration. For fiscal 2021, we forecast that the group will achieve S&P Global Ratings-adjusted debt to EBITDA of 1.8x-2.1x, funds from operations (FFO) to debt of 40%-50%, and substantial positive reported FOCF after all lease-related payments. As the impact from the pandemic on operations wears off, we forecast that H&M will deleverage to less than 2.0x adjusted debt to EBITDA over the next 12-18 months, and FFO to debt will sustainably exceed 45%.

Downside scenario

We could lower the rating if the COVID-19 fallout was more severe than we anticipate, the recovery were to take longer than we currently forecast, including deeper or more protracted economic stress, or if the change in consumer behavior or shopping habits durably weakened the company's competitive position. In particular, we could lower the rating if the company failed to recover its adjusted EBITDA margins from 15.6% in fiscal 2020, or if its cash generation were to weaken sustainably. We could also downgrade H&M if its adjusted debt to EBITDA exceeded 2.0x for longer than 12 months, or if the group were to resume material shareholder remuneration to the detriment of deleveraging.

Upside scenario

We could raise the rating on H&M over the next 24 months if trading recovery exceeded our forecast and the company strengthened its competitive position, including its S&P Global Ratings-adjusted EBITDA margins to historical levels of about 20%, leading to a sustainable improvement in its credit metrics. We consider adjusted debt to EBITDA falling below 1.5x, and a financial policy commitment to durably maintain this metric, for example, through prudent shareholder remuneration, as commensurate with a higher rating.

Company Description

H&M is a Sweden-based apparel retailer of men's, women's, and children's fashion, with some small diversification into the interior accessories segment. Aside from its established H&M brand, the group has also developed or acquired six younger brands (COS, Arket, Weekday, & Other Stories, Monki, and H&M Home), targeting different customer groups, and has also started multi-brand offerings with Afound, Sellpy, and the latest business-to-business initiative Treadler.

H&M operates with a physical presence in about 74 developed and emerging market countries on all continents, with the largest being Germany, the U.S., China, the U.K., France, and Sweden. The group sells merchandise mainly through over 5,000 mono-label stores (brick-and-mortar businesses) and increasingly through its e-commerce channel, which is already rolled out in more than 51 countries. With the exception of Afound, Sellpy, and Treadler, H&M sells mostly private-label merchandise, which it designs and distributes, and cooperates closely with roughly 800 suppliers for production. The group is publicly listed on the Stockholm Stock Exchange with the majority of its shares in free float. The Persson founder family still holds about 49.5% of shares and about 75% of voting rights.

Our Base-Case Scenario

Assumptions

As vaccine rollouts in several countries continue, S&P Global Ratings believes there remains a high degree of uncertainty about the evolution of the coronavirus pandemic and its economic effects. Widespread immunization, which certain countries might achieve by midyear, will help pave the way for a return to more normal levels of social and economic activity. We use this assumption about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

In our forecast for fiscals 2021 and 2022, we assume:

• European and North American GDP will fall by 6.4% and 4.1%, respectively, in 2020 amid a COVID-19-induced slowdown, before rebounding by 4.4% and 4.3%, respectively, in 2021, and 3.6% and 3.0%, respectively, in 2022. We assume real private consumption growth in the eurozone and North America will improve, but that distressed macroeconomic conditions could limit consumer spending on discretionary items for a few years.
• Revenue to rise by 3%-7% in fiscal 2021 following a decline of 19.6% in fiscal 2020. We forecast that sales will likely increase 15%-17% in fiscal 2022, staying short of the pre-crisis level until early fiscal 2023.
• Adjusted EBITDA margin will increase to 16%-17% in fiscal 2021, and 17%-19% in fiscal 2022, following the lowest level on record of about 15.6% in fiscal 2020.
• Working capital efficiencies that will result in an inflow of SEK8 billion-SEK11 billion in fiscal 2021 and normalizing to an annual outflow of up to SEK1 billion thereafter.
• Capex of SEK6.5 billion-SEK7.5 billion in fiscal 2021, with very low share of expansionary capex projects after about SEK5.0 billion in fiscal 2020. We expect capex will increase toward normal levels of SEK8 billion-SEK 9 billion per year thereafter.
• Dividends of up to SEK12 billion in fiscal 2021 and up to SEK16 billion in fiscal 2022, in line with the financial policy commitment to strengthen the balance sheet and our expectation of the pandemic ending this year.
• No material acquisitions.
• Adjusted debt decreasing to SEK60 billion-SEK65 billion in fiscal 2021, driven by lower shareholder remuneration than the cash generated this year, compared with about SEK70 billion in fiscal 2020 (including about SEK65 billion in capitalized lease obligations and net of about SEK13 billion in surplus cash that we see immediately available for debt reduction).

Key metrics

Based on these assumptions, we forecast the following adjusted credit measures for fiscal 2021 and FY2022

• Debt to EBITDA of 1.8x-2.1x in fiscal 2021, decreasing toward 1.5x in fiscal 2022 (compared with about 2.4x in fiscal 2020).
• FFO to debt of 40%-45% in fiscal 2021, increasing to 50%-60% in fiscal 2022 (compared with about 35% in fiscal 2020).
• FOCF to debt of 45%-50% in fiscals 2021 and 2022 (compared with about 30% in fiscal 2020).
• Reported FOCF after leases (in SEK) of about SEK15 billion- SEK17 billion in fiscals 2021 and 2022 (compared with SEK6.5 billion in fiscal 2020).

Liquidity

We view H&M's liquidity as adequate, underpinning the 'A-2' short-term issuer credit rating. We estimate that liquidity sources will likely exceed liquidity needs comfortably by about 1.9x over the next 12 months. Our assessment is also supported by H&M's generally sound relationships with banks and that the company has no financial maintenance covenants in its liquidity facilities. However, the group's reliance on bilateral liquidity lines and so far limited track record in international debt capital markets constrain our assessment. Availability of the bilateral facilities is limited by the substantial drawings due in the next 12 month and relatively short (two-to-four years) maturity profile of the undrawn facilities. Moreover, material risks that could emerge from a prolonged pandemic for the group's cash generation exacerbate concerns over H&M's ability to face low probability high-impact events without refinancing.

Principal liquidity sources over the 12 months from Nov. 30, 2020, include:

• About SEK16 billion of cash and short-term investments, net of SEK1 billion we estimate as required for cash in tills and other operational needs;
• Projected cash FFO of SEK13 billion-SEK15 billion (net of all lease-related payments);
• Inflows from working capital changes of SEK8 billion-SEK11 billion; and
• Undrawn committed facilities of about SEK15 billion denominated in euros and SEK, with more than 12 month to maturity and due in calendar years 2023-2025.

Principal liquidity uses over the 12 months as of Nov. 30, 2020, include:

• Seasonal working capital outflows of up to SEK4 billion;
• Capex of about SEK7 billion;
• Shareholder remuneration of about SEK12 billion; and
• SEK7 billion maturing debt and commercial paper drawings.

Ratings Score Snapshot

Issuer Credit Rating: BBB/Stable/A-2

Business risk: Satisfactory

• Country risk: Intermediate
• Industry risk: Intermediate
• Competitive position: Satisfactory

Financial risk: Modest

• Cash flow/Leverage: Modest

Anchor: bbb+

Modifiers

• Diversification/Portfolio effect: Neutral (no impact)
• Capital structure: Neutral (no impact)
• Liquidity: Adequate (no impact)
• Financial policy: Neutral (no impact)
• Management and governance: Satisfactory (no impact)
• Comparable rating analysis: Negative (-1 notch)

Related Criteria

• General Criteria: Group Rating Methodology, July 1, 2019
• Criteria | Corporates | General: Corporate Methodology: Ratios And Adjustments, April 1, 2019
• Criteria | Corporates | General: Reflecting Subordination Risk In Corporate Issue Ratings, March 28, 2018
• General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
• Criteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014
• Criteria | Corporates | General: Corporate Methodology, Nov. 19, 2013
• General Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013
• General Criteria: Methodology: Industry Risk, Nov. 19, 2013
• General Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities, Nov. 13, 2012
• General Criteria: Principles Of Credit Ratings, Feb. 16, 2011

Related Research

• Industry Top Trends 2021 Retail and Restaurants, Dec. 10, 2020
• Credit Conditions Europe: Waiting For Relief, Dec. 3, 2020
• EMEA Retail And Restaurants: Industry Overview, Credit Trends, And Outlook, Oct. 16, 2020

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