IKKS : Preparing for the Q3 2016 results presentation

IKKS is due to report Q3 2016 results on the morning of 30 November. Hit by a sharp deterioration in H1 2016 results and negative actions by rating agencies in July (S&P) and September (Fitch), the IKKS 2021 bonds have plunged by more than 20pts year to date to 74.2%. At this price, they offer a YTW of 14.6% – a clear outlier in the single B segment. While questions can legitimately be asked about the opportunity offered by this yield, we think it is a little too soon to restore a Buy recommendation. - >Q3 results expected to be much weaker - Like the rest of the sector, IKKS is expected to have suffered in Q3 from: 1/ a very tough summer for the global clothing market (weather conditions, Nice attacks, etc.); and 2/ expectations of a sluggish start for the new collection in September, when summer temperatures prevailed for most of the month. This quarter will also be hit a highly demanding comparison base (like-for-like retail sales growth of 7.6% in Q3 2015). As such, we forecast a 7.7% drop in sales at comparable stores in Q3 and a 42% fall in EBITDA, squeezed by a fresh drop in gross margins (due to bigger markdowns during the summer sales period and an unfavourable sales mix) and higher costs (expansion and marketing). Given that Q3 is traditionally the quarter with the highest cash burn (WCR + coupon), we also expect leverage to jump to 6.1x at 30 September from 5.0x at 30 June. That said, liquidity should remain comfortable and covenants are expected to be renegotiated.Four upside or downside catalysts for IKKS 2021 in the short term - In the very short term, four factors need monitoring, since we think they would instantly impact the IKKS 2021 notes: 1/ the scale of the weakening of results/increase in leverage in Q3 (our baseline scenario seems to be priced in today, but a more pronounced drop in EBITDA could rekindle pressure); 2/ the outlook in Q4 (in principle expected to be far better everywhere, especially from November onwards thanks to a support comparison base); 3/ the renegotiation of covenants (we expect the group to obtain a waiver); and 4/ the rating agencies’ (closely related to the other factors), in particular S&P’s reaction, whose B-/negative rating on the group is at risk of falling into the CCC+ category.We advise caution today and reiterate our Neutral recommendation - While questions can legitimately be asked about the opportunity offered by the current yield, we think it is a little too soon to restore a Buy recommendation on the credit today. If our baseline scenario materialises on 30 November, the bonds should rally by a few percentage points (this rally will have to continue in the following quarters to constitute a genuine recovery). That said, downside risk in the case of a disappointment in one of the areas mentioned above (results, Q4 outlook, covenants, rating) could far exceed this modest upside, prompting us to recommend extreme caution. Conversely, the probability of a stronger rally in the very short term (around 10-15pts) with a return to prices seen prior to Q2 earnings release seems modest to us at this juncture (it would necessitate a combination of highly supportive factors: a far smaller drop in Q3 EBITDA than expected, a very bright outlook, renegotiated covenants and a guarantee that the rating will be maintained).