Neiman Marcus Credit Primer

Transcription

1 Neiman Marcus Credit Primer BI Department Stores, North America Dashboard Noel Hebert BI Senior Credit Analyst 1. BI Credit Primer: Neiman Marcus (Bloomberg Intelligence) -- Store traffic at Neiman Marcus continues to be crimped by muted U.S. economic trends, compounded by reduced tourist spending, oil prices at half the 2014 peak and integration challenges with a new inventory management system. This has hurt revenue and margins, lowering Ebitda and driving leverage above 8x. Exposure to gateway cities keeps Neiman vulnerable to currency effects on tourist spending, while 18% of retail square footage is located in Texas, and sensitive at the margin to commodity price trends. Table of Contents Credit Considerations Key Drivers NEW Cash Flow NEW Liquidity NEW Valuation NEW Comparable-store sales have declined for five consecutive quarters and fiscal trailing 12-month adjusted Ebitda is down 19% vs. the year ago period. Online sales were flat for fiscal 1Q, with domestic softness balance by continued growth for the company's international online business, MyTheresa. Credit Considerations Key Drivers 2. Cash-Flow Pressures Build as Neiman Faces Multi-Front Slowdown Neiman Marcus free cash flows may remain under pressure over the intermediate-term as weak revenue trends reduce margins, and as capital expenditure commitments potentially outweigh operating cash flows. Management plans to add more exclusive product to keep core customers engaged, but has limited visibility around when commodity and currency effects may become less of a headwind. Gross leverage has reached 8.8x as Ebitda has fallen 19% over the last five quarters. Prior periods of Ebitda declines for the company coincided with recessions in 2001 and from 2007 to 2009, falling near 20% and 60% for those periods. In the absence of a technical recession, and near record highs in equity markets, Neiman may be confronting a broader change in consumer behavior. Neiman Marcus Interactive Credit Checklist

2 3. Namesake Stores Critical for Neiman, Even With MyTheresa Growth Restoring momentum to namesake stores is Neiman's biggest lever for reversing Ebitda declines of the last six quarters. Full-line Namesake stores generate over half of the company's revenue, with online operations of the brand representing another 22%, according to BI analysis. That compares with less than 15% for Bergdorf Goodman's stores and website. MyTheresa, the company's fast growing international operation, may represent less than 5% of revenue, while off-price may be about 6%. Methodology: Disclosures for guarantor and non-guarantor subsidiaries for the bank facility and 2028 bonds allow revenue for the various business lines to be estimated, given differences in composition of the non-guarantor baskets and sales per-square-foot estimates for the various chains. Estimated Revenue by Business Line: Neiman Marcus 4. Slow Growth, Mature Store Base Make Neiman Story About Leverage 10/17/16 Balance sheet and operational leverage are important to Neiman's investment story, given an operating model reliant more on same-store sales growth than expansion to drive cash flow. A little over 250,000 square feet of retail space was added over the last five years, or about 4%, three-quarters in its off-price chain Last Call, which has lower sales efficiency on a per-square-foot basis. Online grows faster. Owing to its lower operating profit, this will pressure company-level margin performance. Given elevated debt from the 2013 leveraged buyout, preserving margin and driving sales growth are necessary if the company is to meaningfully trim its indebtedness. Few near-term maturities provide a window to reverse recent Ebitda declines, however. Key Points: Comparable Sales Performance: Stores vs. Direct AVAT» Long-Term Margin Trends AVAT» Runway in Debt Maturity Schedule DDIS» 5. Dollar, Oil Still Challenges for Neiman Marcus Despite Reversals Stores located in or near gateway cities, such as New York and San Francisco, represent about half of Neiman Marcus' 7 million square feet, and this will grow with a 2018 opening of Hudson Yards in New York. The strong dollar has hurt tourist spend and led some U.S. customers to shop abroad, according to the company. Another 18% of retail square footage is in Texas, where the Dallas Fed's Manufacturing Outlook was negative for 22

3 consecutive months before turning positive in November. Despite recent trend reversals, WTI crude oil near $52 a barrel remains around last summer's levels and below an average near $80 over the last decade. The U.S. dollar index is a near record highs, with the currency over 25% higher vs. a basket of major world currencies. Full-Line Store Locations: Neiman Marcus 6. Neiman Same-Store Sales Sensitivity to Equities Starts to Break The directional sensitivity of Neiman Marcus' same-store sales to equity price shifts has begun to break down in recent quarters amid changing consumer habits and the relative performance of other pockets of wealth. The S&P has returned 18% over the last year while Neiman's same-store sales have eroded. More muted bond and commodity gains may be mitigating the wealth effect. Meanwhile, slower supply chains leave traditional retailers like Neiman trailing in delivering new fashion to the sales floor. Average household income for Neiman customers is over $150,000 and 40% have a net worth above $1 million. Same-Store Sales vs. S&P 500 Price Change 7. Total Debt Is the Primary Challenge for Neiman Marcus Once Again Neiman Marcus' total debt is the company's primary challenge amid a moderating economy and downturn in sales and Ebitda. This echoes issues that confronted the company in after its first LBO in During that cycle, management aggressively pared back capital spending and managed to reduce inventories to drive free cash flow and bolster its liquidity position, while holding debt just below $3 billion. A second LBO in 2013 took debt to $4.8 billion, even with Ebitda flat to the prior cycle. Capital requirements for technology, a store opening, remodelings and higher interest costs mean less flexibility.

4 That leaves Neiman more sensitive to shifts in Ebitda and could add volatility to bond prices. Gross leverage of 8.8x compares with Nordstrom's enterprise valuation multiple of 6.4x. Debt Structure: Neiman Marcus 8. Ebitda Pressures May Be Magnified in Neiman's Sales Slowdown Neiman Marcus' profitability is sensitive to shifts in sales, on high fixed costs for rent and pro-cyclical promotional patterns that affect revenue fluctuations. The continuation of trends that drove negative same-store sales through fiscal 2016 and into 1Q17 point to decelerating Ebitda and increased leverage in coming quarters. While sales declines may be less than in the recession, debt is 65% higher. Since 2005, the median percentage change in Ebitda is 1.7x the variation in sales. Revenue, Ebitda, CDS Trends: Neiman Marcus Cash Flow 9. Pullback in Capital Expenditures May Aid Neiman's 2017 Cash Flow Neiman Marcus may be able to offset declining margin dollars with a reduction in net capital expenditures to help preserve intermediate term liquidity. Store investments are forecast to fall by $90 million in fiscal 2017 with Neiman between openings: Hudson Yards isn't due until September Assuming modest improvement in gross margin and SG&A, Ebitda may decline about 10%. A 20% decline could result in neutral excess cash flow given estimated cash interest and net capital expenditures. Excess cash is before any net change in working capital items and the net impact of cash charges not otherwise reflected in gross margin and SG&A.

5 Simplified Excess Cash Flow: Neiman Marcus Liquidity 10. Neiman Credit Facility Use Rises, Though Liquidity Still Enough Liquidity for Neiman Marcus of $497 million as of fiscal 1Q17 is comparable to year-ago levels, with revolving credit facility use at its seasonal peak. The revolver provides sufficient liquidity for seasonal working capital and any growth investments amid weak but still positive 12-month free cash flows. The $355 million outstanding under the revolving credit facility at quarter-end resulted in availability of $455 million. A fixed-charge coverage ratio financial covenant, which becomes effective when availability drops below 10%, had the effect of reducing revolver availability by $90 million. Neiman Marcus Liquidity, Covenant Analysis Valuation 11. Neiman May Weather Cycle With Credit Facility, Bond Covenants The terms of about $5.5 billion of debt and credit availability for Neiman Marcus are likely lax enough to enable the company to weather an economic cycle. Ebitda may have to decline by almost half from the latest 12-month level of $544 million before a 1x fixed-charge coverage ratio financial covenant is at risk. However, growth in capital spending for remodels and new stores is pressuring free cash-flow generation and may require added capital if adverse margin trends aren't reversed. Fixed charges, for purposes of the covenant, include cash interest and scheduled principal amortization payable in cash and cash dividends. The pay-in-kind toggle notes could provide flexibility, if needed, as they represent

6 near 20% of interest expense when serviced in cash. Debt Covenant Grid: Neiman Marcus 12. Neiman Creditors Segregated by Guarantors and Collateral Claims 10/17/16 The $6.4 billion LBO of Neiman Marcus in 2013 recapitalized the balance sheet, adding about $2 billion of debt. Unsecured creditors are guaranteed by restricted domestic subsidiaries, while term loan and credit-facility lenders are additionally guaranteed by the holding company. The $125 million of 7.125% notes due 2028 are guaranteed by Neiman Marcus Group Ltd. and have a comparable first lien collateral claim to the term loan, excluding Bergdorf Goodman assets, owing to negative pledge language. Neither the bank facility nor the 2028 notes are guaranteed by the international business, MyTheresa, while the 2028 notes also have a carve-out for two Nevada locations. One is a full-line store and the other a Last Call, a Neiman subsidiary. Organizational Structure: Neiman Marcus 13. Neiman Marcus Term Loans Trade Lower, Toward Multi-Year Lows Neiman Marcus' $2.9 billion term loan trades near 86.5 cents on the dollar, near the multi-year lows of 84 cents reached last February. The loans have declined 4 points after a fiscal 1Q17 earnings report pointed to increased same-store sales and Ebitda pressures for the period through October. Disappointing holiday sales results reported by peers may reflect continued challenges for Neiman in its fiscal second quarter. Neiman's secured leverage of 5.4x current market value compares with sector enterprise values of 6.4x for Nordstrom and 5.5x for Macy's. The company will face negative compounded two-year same-store sales comparisons through fiscal 3Q17.

7 Neiman Marcus Term Loan Pricing 14. Narrowed Neiman Unsecured Notes Variations May Leave PIK Risk The spread between the Neiman Marcus 8% cash pay notes and the 8.75%/9.50% PIK toggle notes has narrowed to 230 bps from the widest levels of 2016 of about 500 bps, when investors were concerned October 2016 interest would be paid in kind. Deteriorating operating performance and high capital spending into 2018 may lead to servicing PIK note interest with new bonds in 2017 and revaluation of those notes. Up to six interest payments on the PIK note can be made in kind or in a cash-notes split. The price differential between the notes has narrowed as bond prices have fallen, to just over 3 points. The current yield for cash pay notes is near 11.5% and 13.2% for the PIK notes if they are serviced in cash and 9.5% if they are serviced in kind. Unsecured Bonds: Neiman Marcus 15. Neiman Marcus CDS-Implied Default Probability Akin to Year Ago The five-year cumulative probability of default of 38% is comparable to the 39% from January 2016, as implied by Neiman Marcus' credit-default swaps. Limited liquidity and the reference security, the legacy 7.125% bonds of 2028, restrict activity in the CDS. Contracts and gross notional amounts have steadily trended lower amid the rolloff of legacy positions.

8 CDS-Implied Cumulative Default Probability To contact the analyst for this research: Noel Hebert at