IKKS : Recommendation cut from Neutral to Reduce

Prices of the IKKS 2021 bonds have returned to 71.75% (YTW of 15.6%) after falling by five points from 73.5% to 68.5% yesterday. Although we were anticipating a very weak Q3, we were somewhat disappointed by this release, especially the outlook for Q4, which we expected to be far better thanks to a supportive comparison base in November (it will become more demanding again in December). The new IKKS Women collection has clearly not won over customers after the initial disappointment this summer. We welcome the more conservative strategic shift for 2017 before these disappointments turn into a lasting image problem, as well as the necessary reduction in capex and the bank support that will allow the group to implement this strategy without putting pressure on liquidity in the short term. In the meantime, we fear that results will continue to flag in the next two quarters (albeit to a lesser extent than in Q3) and that the group’s ratings remain at risk. In addition, the success of the strategic shift still has to be confirmed in 2017 by the speed at which customers return, all this in an often turbulent retail environment (weather conditions and security context). We have a Reduce recommendation pending a clear turnaround. - >Sharp drop in Q3 2016 results and a disappointing outlook - IKKS reported Q3 sales down 8.4% and 16.3% at comparable stores, far exceeding our forecast (-7.7%) and sharply underperforming the market, including for the new Autumn/Winter collection (-27%!). EBITDA plunged by 46.5% in Q3 to € 8.3m, sending the EBITDA margin down by 800bp to 11.2%. Above all, the group reported a small drop in comparable stores at this point in Q4 2016, even though the comparison base was supportive in November (-6.3% like-for-like in November 2015 because of warm weather and terrorist attacks in Paris) and we had high hopes of seeing a recovery. This confirms that the new collection (IKKS Women) has been another disappointment after the failure of the Spring/Summer 2016 collection. A sharp increase in leverage, but the banks are supportive - IKKS generated negative free cash flow of -€ 35m in Q3 after interest expense and taxes, broadly in line with our forecast (-€ 36m), pushing leverage up to 6.2x (we were forecasting 6.1x) vs. 4.7x at 30 September 2015. As we were also hoping, the group announced good news on the banking front, with an easing of covenants and the arrangement of a € 5m unsecured medium-term loan. Liquidity is no longer at risk in the short term, especially as Q4 is a cash-generating quarter (we forecast FCF of € 25m, which would cut leverage to 5.9x).A more conservative strategy in 2017 - IKKS said that it would restore a more conservative strategy in 2017, with a Spring/Summer collection more in tune with its historical DNA and a slowdown in its expansion strategy. We welcome these changes. Bringing capex back to the 2015 level seems to us to be the minimum requirement to restore positive free cash flow generation pending the return of sales and EBITDA growth, which will require luring back traditional customers. The timing is right given that the brand was probably only one collection way from suffering a lasting loss of customers, in our view. It is also possible that recapturing all traditional customers will not be an automatic process at the first change of collection and will take a little time. Marketing efforts will probably be necessary. In the meantime, results are likely to remain under pressure, putting the ratings at risk.