Fitch Ratings has upgraded Capri Holdings Limited's and Michael Kors (USA), Inc.'s ratings, including their Long-Term Issuer Default Ratings (IDR) to 'BBB-' from 'BB+'.
The Outlook is Stable.
The upgrade of Capri's IDR to its pre-pandemic rating reflects its improving topline trajectory which led to LTM June 2021 EBITDA of approximately $1.1 billion, similar to pre-pandemic levels. EBITDA improvement alongside continued debt reduction, including approximately $870 million of paydown in the fiscal year ended March 2021, have improved Fitch's confidence in Capri's ability to sustain adjusted leverage in the low-3x, as appropriate for the 'BBB-' rating.
Capri's rating continues to reflect its strong positioning in the U.S. handbag market, historical growth at its various brands and its commitment to debt reduction. The rating also considers the fashion risk inherent in the accessories and apparel space.
Key Rating Drivers
EBITDA Rebound: Capri's LTM June 2021 EBITDA of $1.1 billion is close to calendar 2019 levels, the result of a good sales rebound from the pandemic trough and cost control. Revenue during the June 2021 LTM was $4.9 billion, well above the $4.1 billion trough in calendar 2020 albeit below the $5.7 billion achieved in calendar 2019. LTM EBITDA margins were approximately 23%, above the approximately 20% prior to the pandemic on structural cost reductions, topline shifts to higher-margin retail sales from the wholesale channel and reduced inventory purchases, which have reduced markdown activity.
Fitch projects revenue could reach $5.2 billion in fiscal 2022 (ending March 2022) and trend in the mid-$5 billion range beginning fiscal 2023. Revenue at the Michael Kors brand (approximately 72% of projected fiscal 2022 company revenue) may not fully rebound to pre-pandemic levels given both store closures and proactive wholesale account pullbacks. EBITDA is expected to trend close to the $1.1 billion recorded in the LTM, with margins declining to the 20% range assuming some topline investments and markdowns are reintroduced over time. Fitch recognizes a number of unknowns continue to exist, including the levels of pent-up and pull-forward demand which may have benefitted 1H21 apparel and accessories sales, and the potential impact of rising delta variant cases on consumer behavior.
Longer Term Pandemic Impacts: Capri's initiatives and competitor actions during the pandemic could benefit leaders in the apparel and accessories space such as Capri. Capri and other scaled players with good infrastructure and cash flow used the past 18 months as an opportunity to accelerate omnichannel investments, eliminate unproductive expenses, streamline processes to improve corporate speed and agility, prune real estate portfolios and reorient internal functions like marketing to align with broader changes in the consumer landscape. At the same time, the retail landscape has seen store closures from strong and weaker players as well as larger scale retrenchment by, or even elimination of, struggling industry participants.
Capri's internal initiatives and some reduction to the competitive landscape should improve the company's revenue prospects in the medium term. Cost reductions both support margins and permit incremental opportunities for topline investments. Finally, reduced industry square footage should lead to lower industry-wide inventory levels of apparel and accessories, which could structurally reduce industry markdown activity.
Demonstrated Financial Conservatism and Flexibility: Capri's good credit profile is underscored by its actions and financial flexibility since the beginning of the pandemic. The company maximized near term cash flow through payables negotiations, lower inventory buys and material reductions to discretionary operating and capital expenditures. Capri accelerated the closure of less productive Michael Kors stores (820 stores as of June 26, 2021 compared with 846 at the end of 2019) which reduced its longer-term rent burden. Finally, the company paid down approximately $700 million of debt in calendar 2020 yielding $1.3 billion in debt today, in line with the company's financial target of below 2.0x net leverage (using operating lease liabilities; Fitch-adjusted equivalent is at or below low-3x).
Capri's good financial flexibility during the pandemic was supported by FCF of over $500 million during fiscal 2021, reasonable levels of cash on hand and uninterrupted access to its $1 billion cash flow revolver. Fitch expects these factors to continue to benefit Capri's credit profile over the next two to three years, including continued debt reduction using FCF which Fitch projects at around $600 million in fiscal 2021 and the $700 million range beginning fiscal 2022.
Leading Position; Recently Volatile Results: The Michael Kors brand is well positioned in the global accessories and apparel market, and essentially shares the leading position in the U.S. handbag market with the Coach brand (owned by Tapestry, Inc., BBB-/Stable).
Following a strong history of growth, revenue for the brand peaked in fiscal 2016 at $4.7 billion, before falling to $4.35 billion in calendar 2019. Fitch believes some of these challenges were macro-driven, given challenges facing many mall-based fashion-oriented retailers. Headwinds include reduced interest in fashion and increased industry markdown levels needed to prompt consumer action and clear inventory.
Prior to the onset of the pandemic, the company saw some signs of revenue stabilization through its renewed focus on product design, store remodels, and expansion of underpenetrated categories. The company also reduced promotional activity, pulled back department store exposure and closed underperforming stores. These efforts led to revenue and EBITDA stabilization during the three fiscal years ended March 2019. However, Michael Kors's revenue in the subsequent three quarters (prior to the onset of the pandemic in the March 2020 quarter) fell an average of 5%.
Acquisitive Posture: Capri's portfolio has evolved via acquisitions in recent years, somewhat benefiting its credit profile through diversification.
In November 2017, the company purchased luxury shoe and accessory maker Jimmy Choo PLC for $1.35 billion, or 16.5x EV/EBITDA (based on Fitch-defined EBITDA for the 12-month period ending June 30, 2017) which it financed with $1 billion of unsecured term loans (later repaid) and $450 million in unsecured notes.
On Dec. 31, 2018, Capri purchased Gianni Versace S.p.A., an independently operated luxury goods company, for $2 billion (valuation unavailable given a lack of financial information on the asset). Capri Holdings partially financed the purchase of Versace with $1.6 billion in unsecured term loans. As of June 26, 2021, $846 million remained outstanding on the term loan facility, which was secured in June 2020.
The Jimmy Choo acquisition increased Capri's revenue penetration of women's shoes, while the Versace brand increased Capri's exposure to the apparel category and to male customers. Both of these brands have European heritages and given their international penetration reduce Capri's exposure to the Americas.
Derivation Summary
Capri's upgrade to 'BBB-'/Stable reflects its improving topline trajectory and sustainable cost reductions, which led to LTM June 2021 EBITDA of approximately $1.1 billion, similar to pre-pandemic levels. EBITDA improvement alongside continued debt reduction, including approximately $870 million of paydown in the fiscal year ended March 2021, have improved Fitch's confidence in Capri's ability to sustain adjusted leverage in the low-3x, as appropriate for the 'BBB-' rating.
Capri's ratings continue to reflect the company's longer-term growth trajectory, strong positioning in the U.S. handbag and small leather goods market, and efforts to deploy FCF toward debt reduction following acquisitions. The rating also considers the fashion risk inherent in the accessory and apparel space, illustrated by the Michael Kors brand's topline weakness in recent years pre-pandemic.
Tapestry, Inc.'s BBB-/Stable rating reflects its improving topline trajectory and sustainable cost reductions, which led to fiscal 2021 (ending July 3, 2021) EBITDA of approximately $1.4 billion, similar to pre-pandemic levels. EBITDA improvement alongside Tapestry's recently announced intention to repay $400 million of unsecured notes due July 2022, have improved Fitch's confidence in Tapestry's ability to sustain adjusted leverage in the low-3x, as appropriate for the 'BBB-' rating.
Tapestry's ratings also reflect its strong brand positioning at Coach (around 90% of segment EBITDA), and its leading market share within the U.S. premium handbag and small leather goods market. The rating also considers the fashion risk inherent in the accessories and apparel space.
Levi Strauss & Co. (BB+/Stable) is of similar size and profitability to Tapestry and competes in a space (clothing) that is susceptible to fashion risk. Based on EBITDA declines, adjusted leverage increased to approximately 6.0x in fiscal 2020 (ended November 2020) from 3.1x in fiscal 2019. Fitch expects that EBITDA will approach pre-pandemic levels in fiscal 2021 (ending November 2021) based on a rebound in revenue, good cost control, and channel shifts toward the more profitable direct-to-consumer channel. As such, Fitch expects adjusted debt/EBITDAR (capitalizing leases at 8.0x) to improve below 3.5x in fiscal 2021.
Kohl's Corporation (BBB-/Stable): Kohl's ratings reflect its position as the second largest department store in the U.S. and its well-developed omnichannel strategies, with digital sales expected to contribute to approximately 35% of revenues going forward. Kohl's off-mall real estate footprint provides some insulation from mall traffic challenges. Assuming a sustained topline recovery, EBITDA could return to 2019 levels of $2.5 billion and adjusted debt/EBITDAR could return to under 3.0x in 2022.
Nordstrom, Inc. (BBB-/Negative Outlook): Nordstrom's ratings reflect its historically good market position in the apparel, footwear, and accessories space, with its differentiated merchandise and high level of customer service enabling the company to enjoy strong customer loyalty. However, the Negative Outlook reflects concerns that recent pre-pandemic operating challenges could suggest some combination of execution shortfalls and increased susceptibility to secular headwinds in the department store space, which could limit the company's ability to return revenue and profitability close to pre-pandemic levels.
Key Assumptions
Fitch's Key Assumptions Within Our Rating Case for the Issuer
Capri's fiscal 2022 (ending March 2022) revenue is projected to expand close to 30% to around $5.2 billion from $4.1 billion in fiscal 2021, but remain below the $5.7 billion recorded in calendar 2019. To meet Fitch's expectation given Capri's reported first fiscal quarter results, topline for the remaining nine months of the fiscal year would need to be approximately $3.9 billion, compared with $3.6 billion for the nine months ended March 2021 and $4.2 billion for the nine months ended March 2020. Fitch projects around 4% growth in fiscal 2023 to $5.4 billion, with around 2% annual expansion beginning fiscal 2024.
EBITDA, which rebounded from a $700 million low in the September 2020, TTM, improved to $1.1 billion in the June 2021 TTM, close to pre-pandemic levels, and Fitch expects EBITDA could remain in the $1.1 billion range beginning fiscal 2022. EBITDA margins improved to 23% in the TTM June 2021 relative to the 20% range prior to the pandemic, on reduced markdown activity and good cost control. Fitch projects EBITDA margins could trend toward pre-pandemic levels beginning fiscal 2023 assuming some investments in topline acceleration and somewhat higher levels of markdowns.
FCF is expected to be around $600 million in fiscal 2022 assuming some inventory build, and around $700 million beginning fiscal 2023 on neutral working capital. FCF averaged $650 million over the past four years, including just over $500 million in fiscal 2021. Fitch expects Capri to deploy FCF toward debt reduction, in line with its recent history and financial policy. As of June 26, 2021, the company has approximately $850 million of pre-payable unsecured term loans due November 2023 and $450 million of unsecured notes due September 2024.
Adjusted debt/EBITDAR, which has been somewhat volatile in recent years given the debt-financed purchase of Versace in fiscal 2019 and the onset of the coronavirus pandemic at the end of fiscal 2020, was approximately 3.3x as of June 2021. Adjusted debt/EBITDAR is projected to be in the low-3x at the end of fiscal 2022 on debt repayment and could remain in the low-3x, as appropriate for the 'BBB-' rating, assuming EBITDA remains near $1.1 billion and assuming the company refinances upcoming maturities. Adjusted leverage could improve below 3.0x if the company continues to reduce debt beyond 2022.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
A positive rating action could result from low single digit sales and EBITDA growth, which, combined with debt reduction, would yield total adjusted debt/EBITDAR (capitalizing rent at 8.0x) sustaining below the high-2x range.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
A negative rating action could result from EBITDA declining below $1 billion, suggesting longer term brand challenges and which could cause adjusted debt/EBITDAR (capitalizing rent at 8.0x) to sustain above the low-3x range.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Adequate Liquidity: As of June 26, 2021, the company reported $356 million in cash and no borrowings outstanding on its $1 billion revolving credit facility maturing November 2023. After accounting for LOC outstanding, the amount available on the revolving credit facility was $972 million. The company's debt structure as of June 26, 2021 consisted of approximately $850 million of term loans due November 2023 and $450 million in unsecured senior notes due September 2024.
The revolving credit facility and term loans have been affirmed at 'BBB-' with the recovery rating of 'RR1' removed. The unsecured senior notes have been upgraded to 'BBB-' from 'BB+'/RR4.
In June 2020, Capri amended its revolving credit and term loan facility and entered into a new $230 million 364-day secured revolving credit facility to improve liquidity; the 364-day facility has since been terminated. With this amendment, the company's revolving credit and term loan facility were amended so that they are secured by certain U.S. assets plus all of the company's intellectual property. The amendment contains a security fall-away provision if Capri is rated investment-grade, with a Stable or better Outlook, by two of three selected ratings agencies. Fitch believes this condition is likely to be met. Under this scenario, Fitch would rate the senior unsecured credit facility and term loans 'BBB-'.
Issuer Profile
Capri Holdings Limited is a leading global manufacturer and retailer of accessories and leather goods, primarily handbags, and footwear. Historically, the company operated solely as the Michael Kors brand. Beginning in 2017, the company began to pursue an M&A strategy to diversify its operations. The company's portfolio consists of three brands: Michael Kors, Jimmy Choo, and Versace.
Summary of Financial Adjustments
Historical and projected EBITDA is adjusted to add back non-cash stock-based compensation and exclude non-recurring charges. For the fiscal year ending March 27, 2021, Fitch added back $71 million in stock-based compensation expenses, $316 million in impairment charges, $32 million in restructuring charges, $2 million in ERP implementation charges, and $42 million in COVID-related charges to EBITDA. Fitch has adjusted the historical and projected debt by adding 8.0x annual gross rent expense.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg
RATING ACTIONSENTITY/DEBT RATING PRIOR
Michael Kors (USA), Inc. LT IDR BBB- Upgrade BB+
senior unsecured
LT BBB- Upgrade BB+
senior secured
LT BBB- Affirmed BBB-
Capri Holdings Limited LT IDR BBB- Upgrade BB+
senior secured
LT BBB- Affirmed BBB-
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CAPRI HOLDINGS LIMITED 
