Rating Action Overview

• Luxury department store NMG Holding Co. Inc. (Neiman Marcus) faces difficult operating conditions and inventory challenges as consumer discretionary spending weakens, even for the high-end shopper.
• We expect elevated leverage and challenged free operating cash flow (FOCF) for 2023 amid ongoing clearance activity and softer consumer demand.
• Therefore, we revised our outlook on Neiman Marcus to stable from positive and affirmed all our ratings, including our 'B-' issuer credit rating on the company.
• The stable outlook reflects our expectation that performance will remain pressured with modest margin compression, resulting in S&P Global Ratings-adjusted debt to EBITDA above 7x.

Rating Action Rationale

The outlook revision reflects the weaker-than-expected credit metrics in 2023 amid a challenging operating environment. The current weakening of consumer demand for discretionary products, retailer inventory realignment, and inflationary headwinds continue to pressure Neiman's performance. Neiman reported a net sales decline of 9.4% in the third quarter ended April 29, 2023, relative to the comparable period in 2022. Both comparable sales from store and online operations experienced a decline, specifically down 5% and 17%, respectively, primarily due to softening demand.

While we recognize the supply chain and post-pandemic demand right-sizing challenges across department stores and other retailers, this performance was still materially below our expectations, with S&P Global Ratings-adjusted EBITDA margins declining more than 300 basis points in the third quarter. This caused adjusted leverage for the last 12-month period to spike to 7.4x compared with our previous expectation for leverage of about 5x in 2023. We believe the company remains vulnerable to weakening macroeconomic conditions and the challenges it faces in the narrow luxury department store sector. We anticipate the operating environment will also remain difficult as department stores face increased competition from online retailers and luxury consumer brands.

S&P Global Ratings-adjusted EBITDA margins will remain pressured in the near term. Neiman has experienced a decline in product margins due to increased markdowns and promotional costs stemming from the highly competitive promotional environment, as well as measures undertaken to clear excess inventory. We expect continued margin pressure in the fourth quarter before abating in 2024. Neiman has also taken liquidation measures to optimize capacity and expedite the clearance of excess inventory as part of its supply chain transformation initiatives, which we believe will continue into the fourth quarter (which ends July 31, 2023). We believe these actions to right-size its inventory should put Neiman in a better position in 2024, and we forecast margins improving at least 150 bps.

We anticipate leverage to be above 7x in 2023 before declining over the next 12 months because improved margins should partly offset the soft topline. Given the recent softer sales and the challenging year-over-year comparisons, which were bolstered by strong consumer spending, we anticipate around a 3% decline in revenue for 2023. We believe profitability will somewhat rebound in 2024 because of cost-saving initiatives, supply chain transformation efforts, and reduced clearance activity.

Weaker operating performance combined with slightly higher capital expenditures led to negative generation of free operating cash flows (FOCF) of about $290 million during the nine months of fiscal 2023. We forecast negative FOCF in 2023 and believe improvement in 2024 is largely dependent on inventory reduction. In the third quarter, inventories were up 23% compared with 39% in the second quarter. We believe there will be continued deceleration in inventory levels, which should support improvements in FOCF.

We continue to view the company's liquidity position as adequate. As of April 29, 2023, the company had $95 million of cash on hand and about $880 million of availability under its asset-based lending (ABL) facility. We do not foresee any immediate liquidity issues given the company's lack of near-term maturities and sufficient covenant headroom. However, we do note that Neiman's ABL matures in September 2024, and liquidity could become constrained if the company does not refinance or extend it by September 2023. The $1.1 billion in senior secured notes mature in April 2026.

Outlook

The stable outlook reflects our expectation that performance will remain pressured with modest margin compression, resulting in S&P Global Ratings-adjusted debt to EBITDA above 7x.

Downside scenario

We could lower our rating if:

• Neiman were unable to stabilize performance through the successful execution of operating initiatives, including restoring profitability to historical levels and returning to positive FOCF generation; and
• Liquidity became constrained and the company is unable to refinance or extend its ABL in a timely manner.

Upside scenario

We could raise the rating if:

• We anticipated Neiman would maintain sales growth and EBITDA margin improvement, demonstrating that it can effectively compete in an evolving retail environment. Under this scenario, we would expect leverage to be sustained in the low-5x area with at least $50 million of annual FOCF generation.
• We believed the company had a financial policy that supported leverage maintained at this level.

Company Description

Dallas-based Neiman Marcus operates as a luxury department store and omnichannel retailer. The company markets a wide assortment of apparel and related goods through the Neiman Marcus, Bergdorf Goodman, and Last Call segments. Following emergence from bankruptcy, the company will operate 36 Neiman Marcus, two Bergdorf Goodman, and Five Last Call stores throughout the U.S., as well as its e-commerce operations.

Our Base-Case Scenario

• S&P Global Economists forecast U.S GDP growth of 1.7% in 2023 and 1.3% in 2024 while unemployment declines to 5% in 2023 and 3.3% in 2024.
• Revenue declines about 3% in fiscal 2023 mainly due to softening consumer demand in discretionary spending and decreasing online sales. We expect a gradual increase in the low-single-digits percent area mainly driven by a single-digit increase in online sales in fiscal 2024.
• We expect S&P Global Ratings-adjusted EBITDA margins to decrease substantially to the mid-single-digit percent area in fiscal 2023 primarily due to increased markdowns and higher labor and facility costs. We project margins to increase by 150-200 bps in fiscal 2024 led by better product margins and slightly lower operating costs.
• Capital spending of about $210 million in fiscal 2023 to support investments in merchandising, technology, and supply chain. Capital spending decreases to $150.0 million-$180.0 million in fiscal 2024.
• Modestly negative FOCF in the $250 million-$300 million range for fiscal 2023, remaining slightly negative in 2024.

Based on these assumptions, we project the following credit metrics:

• Anticipated leverage to worsen to above 7x due to weaker operating performance in fiscal 2023 followed by improvement to the mid-5x area in fiscal 2024.

Liquidity

We assess Neiman's liquidity as adequate, with sources to meaningfully exceed uses and positive net liquidity over the next 12 months. While the company qualifies for a higher assessment based on our quantitative assessment, it is limited by qualitative factors. Included among these is our view the company cannot absorb high-impact, low-probability events without refinancing, and the company's current standing in credit markets is less than satisfactory given its recent path through bankruptcy.

Principal sources of liquidity:

• Balance sheet cash of $94.8 million as of April 29, 2023.
• Availability of $882.3 million under the $900.0 million asset-based revolving credit facility, excluding $17.7 million letters of credit.
• Cash FFO in the range of $130 million-$145 million over the next 12-24 months.

Principal uses of liquidity:

• Working capital outflows, and
• Capital expenditures of $150.0 million-$180.0 million over the next 24 months.

Covenants

The ABL is subject to a springing 1x fixed-charge coverage ratio covenant when excess availability is less than the greater of (a) $65 million and (b) 10% of the line cap then in effect.

We expect the company to remain compliant with the ABL covenants over the next 12 months.

Issue Ratings - Recovery Analysis

Key analytical factors

• Our simulated default scenario assumes department stores continue to face increased competition and negative impacts from shifts in consumer preferences that, along with a weakened macroeconomic environment, lead to negative same-store sales, declines in e-commerce revenue, and a drastic decline in EBITDA.
• Our analysis assumes lender recoveries would be maximized if the company emerged from the hypothetical bankruptcy event as a going concern, and we have applied a 5x multiple to our projected emergence-level EBITDA.

Simulated default assumptions

• Simulated year of default: 2025
• Implied enterprise value multiple: 5x
• Estimated gross going-concern value at emergence: about $1.3 billion

Simplified waterfall

• Net enterprise valuation after 5% administrative costs and assumed pension claims: $1.1 billion
• Priority claims, including an estimated 60% draw on the ABL facility at default minus assumed outstanding letters of credit: About $537 million
• -First-lien claims: About $1.13 billion*
• --Recovery expectations: 50%-70% (rounded estimate: 50%)

*All debt amounts include six months of prepetition interest

Ratings Score Snapshot

ESG credit indicators: E-2, S-2, G-2

Related Criteria

• General Criteria: Environmental, Social, And Governance Principles In Credit Ratings , Oct. 10, 2021
• General Criteria: Group Rating Methodology , July 1, 2019
• Criteria | Corporates | General: Corporate Methodology: Ratios And Adjustments , April 1, 2019
• Criteria | Corporates | General: Recovery Rating Criteria For Speculative-Grade Corporate Issuers , Dec. 7, 2016
• Criteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers , Dec. 16, 2014
• General Criteria: Country Risk Assessment Methodology And Assumptions , Nov. 19, 2013
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• Criteria | Corporates | General: Corporate Methodology , 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

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