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Investing.com -- S&P Global Ratings has downgraded New York-based Foot Locker (NYSE:FL) Inc.’s issuer credit rating from ’BB’ to ’BB-’ due to ongoing operational margin pressures in fiscal 2024. The rating agency also adjusted the rating on the company’s senior unsecured notes to ’BB-’ from ’BB’. The recovery rating, which reflects the expected recovery rate in case of default, remains at ’3’, indicating a projected recovery of 50%-70%.
Foot Locker, a footwear and apparel retailer, is anticipated to face continued challenging operating conditions due to promotional activities and a weak consumer environment. The downgrade is a reflection of Foot Locker’s persistent weak operating performance in a highly competitive market.
Despite an increase in the company’s S&P Global Ratings-adjusted EBITDA margin to about 13% in fiscal 2024, up from the low-12% area in 2023, the company’s profitability has significantly declined in recent years. The decline in profitability is attributed to increased competition and excess inventory, which has led to a highly promotional environment.
Foot Locker’s main vendor, Nike (NYSE:NKE), has shifted its strategy towards direct-to-consumer (DTC) and digital sales, pulling merchandise from select retailers, including Foot Locker. This shift has negatively impacted Foot Locker’s operating performance.
Foot Locker’s exposure to Nike decreased to about 60% in 2024, down from 65% in 2022. Meanwhile, the company increased its ecommerce channel to approximately 18%. Despite these changes, Foot Locker’s operating performance remains under pressure due to potential delays in Nike’s turnaround plan.
Foot Locker reported a free operating cash flow (FOCF) of $105 million in 2024, after two years of deficit. The company has been investing in brand strengthening and consumer experience enhancement, while also reducing its store fleet. In addition, the company has allocated more capital towards technology in recent years to compensate for previous underinvestment.
The company’s total sales fell by over 2% in 2024 due to about 113 net store closures and foreign currency headwinds. However, comparable sales increased by about 1.4% due to the continued execution of its Lace Up plan.
Despite these challenges, Foot Locker anticipates positive comparable sales this year as it continues to execute its transformation initiatives. However, persistent inflationary pressures pose a risk to the company’s efforts to drive traffic.
Foot Locker’s S&P Global Ratings-adjusted leverage is expected to remain within the 2x area and improve over time due to higher EBITDA margins. The company stopped paying dividends in 2024, which helped preserve cash. It also has an undrawn $600 million asset-based lending (ABL) facility due in 2029, providing sufficient liquidity to execute its turnaround initiatives.
The stable outlook provided by S&P Global Ratings reflects an expectation of improved profitability and higher FOCF as Foot Locker continues to execute its Lace Up plan. Ratings could be further lowered if the company fails to improve its operating margins or generate meaningful FOCF due to potential setbacks in its turnaround plans. Conversely, ratings could be raised if Foot Locker successfully executes its transformation initiatives, leading to consistent operating margin improvements and healthier FOCF.
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