SMCP : Luxury (bonds) less and less affordable

Wednesday, 14 December 2014 - / - End-April: Q4 2016 results - - - - Following Q3 2016 earnings release, and the outstanding performance of the 5.875% 2023 BiSoho bond since its issuance in May, we shall take a fresh look at the credit. We cheer the group’s strong performance in Q3 in a particularly challenging context in France and we are maintaining our positive credit opinion on the name. Given the performance of the 2023 bond which price now stands at 108.25%, virtually the highest level since its issuance, we must admit however that a possible outperformance appears now to be less likely. As a result (and with regret!), we are lowering our recommendation from Buy to Neutral (hold). - >SMCP posted very reassuring Q3 2016 results - In a particularly sluggish environment for clothing in France in Q3 (with -11.9% in September), SMCP posted positive growth on a same-store basis (+3.3% and +11.2% in reported terms), with an 8.9% increase in EBITDA. The group benefited from its geographic diversification and the success of the collections of its three brands. The group also said that it was satisfied with sales in October and November. We are expecting Q4 earnings to be stronger as 1) Q3 outperformance has once again proved the attractiveness of the autumn/winter collections and 2) the base effect will become easier in France (favourable weather conditions + impact of the Paris terror attacks in November 2015).Leverage was reduced to 2.5x at end-September 2016. We estimate leverage to be 3.9x pro forma acquisition by Shandong Ruyi - The group's operating performance is reflected in solid free cash flow generation (€ 42m over twelve months after financial expenses, i.e. 5.5% of the LTM sales), which lowered the group’s leverage to 2.5x at end-September 2016 vs. 3x at end-2015 (and from 3.8x to 3.5x on a lease-adjusted basis). Given that the acquisition by Shandong Ruyi was finalised in Q4 (October), the new scope of consolidation with the additional debt will be recorded at end1eDecember 2016 for the first time. We estimate pro-forma leverage at 3.9x (and at 4.3x on an adjusted basis and 5.7x PIK loan included). These increases did not impact the group’s ratings.We are maintaining our positive credit opinion but we believe that the bond now offers less potential - We remain very confident about the name in terms of credit (positive credit opinion maintained), given the recurring success of collections (with a team of designers that remains in place after change of control) and a perfectly controlled international development which should now enjoy the alliance with Shandong Ruyi in Asia. The potential for debt reduction is estimated at 0.5x/0.7x per year driven by FCF generation and we would not be surprised to see the group upgraded to B1/B+ next year. We recommended to subscribe to the 5.875% 2023 BiSoho bond in May. The bond has strongly performed since its issuance, gaining more than 8 points and trading today at 108.25%, a YTW of 3.5% (pricing at call 19). At this level, we must admit that SMCP is one of the most costly single-B issuers on the market (like Autodis, Matterhorn or Verallia), and that an upgrade to B1/B+ seems already integrated. For this reason, the potential for the bond’s outperformance appears to be less likely than before. We are downgrading our recommendation to Neutral from Buy (hold on the credit).