It was not a good Friday for Kohl’s.
Standard & Poor’s downgraded the Menomonee Falls, Wis.-based Kohl’s Corp. to “BB” from “BB+” citing its weaker-than-expected fourth-quarter results, lower margins, heightened clearance activity and “muted” demand.
BB is considered a junk rating. It suggests an elevated vulnerability to default risk if there are significant changes in the business or the economy, though a company maintains flexibility to meet financial commitments.
But it’s not all bad.
In its report on Kohl’s issued Friday, S&P said it expects better metrics in 2023 as the company improves merchandising execution with lower inventory levels, freight costs ease and continues the rollout of Sephora shops inside its stores.
S&P also cited reduced capital expenditures, which should help profitability, after outsized spending in the last few seasons due to the rapid rollout of Sephora shops. S&P sees favorable market trends in beauty and said Sephora has a strong market position.
Watch on FN
In addition, S&P cited the possibility that Kohl’s starts to build up revenue again in 2024, after declines in 2023, and said the retailer’s off-mall locations, which account for about 95% of the total fleet of stores, are “a benefit as they contribute to the company’s lower cost structure and provide better accessibility and convenience for customers.”
“Still, we believe operating margins will remain below historic levels and stay at about 4 percent,” S&P reported. “We also note macroeconomic risks as the economy slows, which could impair consumer spending and pressure sales more than the low-single-digit percent decline we anticipate in our base case for fiscal 2023.”
The ratings agency said the downgrade reflects “the significant deterioration of Kohl’s free operating cash flow and leverage.”
“We believe inventory levels at the end of 2022 appeared appropriate following clearance activity, up roughly 4% compared with the prior year,” S&P stated. “However, given the mixed recent track record, we see risks of markdowns that could continue to pressure profitability over the coming year. We assume initiatives will gradually improve profitability over the next several years, with revenue declining in 2023 and slowly building back from that point. As a result, S&P lease adjusted leverage remains above 3x through 2024. Due to the company’s anticipated weaker credit measures and volatile operating results, we revised our financial risk profile assessment to ‘significant’ from ‘intermediate.’”
S&P expressed some caution regarding recent management changes, including the appointment last February of Kohl’s new CEO Tom Kingsbury, although he has a strong reputation in retailing considering his successful transformation of Burlington Stores. Kingsbury succeeded Michelle Gass, who left Kohl’s to became president and CEO-elect of Levi’s. In another key executive change just a week after Kingsbury’s appointment, Nick Jones, a 25-year retail veteran, was named chief merchandising and digital officer, succeeding Doug Howe.
“Considering this turnover and the weaker recent operational execution relative to some apparel peers, we have an incrementally less favorable view of the company’s strategic planning process and its management depth and breadth,” S&P indicated. “As a result, we are revising our management and governance score to ‘fair’ from ‘satisfactory.’”
“We believe department stores continue to face mounting competitive pressures and ongoing execution risk to maintain market share. Declining physical store traffic, shifting category preferences, and online price transparency are persistent longer-term risks for Kohl’s business, in our view.”
This story was reported by WWD and originally appeared on WWD.com.