Standard & Poor’s on Thursday cut the ailing Gap’s credit rating three notches to junk status, citing the disappointing sales and earnings at the largest U.S. specialty apparel retailer. Moody’s Investors Services, meanwhile, lowered its Gap rating two notches to “Ba2,” which is also junk status, from “Baa3.”
By the end of the day, Gap stock dropped 55 cents, or 4.12 percent, to close at $12.79 on the New York Stock Exchange. Gap stock has been trading 63.4 percent lower than its yearly high reached on May 17 of $34.98.
The developments overshadowed the San Francisco-based retailer’s announcement Thursday that it received a $1.3 billion credit facility from major commercial banks, which is to be used toward the completing of a new two-year secured bank agreement. The new facility will replace the company’s existing $1.3 billion, 364-day bank facility, which expires in June, as well as its $150 million facility expiring in June 2005. Because of Gap’s lower credit ratings, it faces higher borrowing costs. The new facility is subject to closing conditions and is expected to close the week of March 4.
“We are tightly managing our business by controlling variable expenses and reducing capital spending,” Gap’s vice chairman John Lillie said in a statement. “Our emphasis on cash management helps our brand focus on what’s most important — improving comparable-stores sales by delivering the right product and shopping environments to our customers.”
The downgrades are just more bad news for Gap, which is coming off one of the worst performances in its history. November and December comps plummeted 25 percent and 11 percent, respectively. Now Wall Street analysts expect Gap to report a loss of 4 cents in its fourth quarter, compared with the 31 cents earned in the year-ago period.
For the past couple of years, retail analysts have criticized Gap’s fashion choices, saying the chain had mistakenly abandoned its roots of popular and quality fashion basics, particularly khakis and jeans, in favor of trendier items aimed at younger and hipper populations.
Gap’s chief executive officer Mickey Drexler has promised a turnaround will begin this spring across all divisions. As reported, Gap Inc. is already offering discounts on spring merchandise at Gap and Old Navy stores, prompting some analysts to question whether sales are already off to a slow start, though price slashing is being seen at many other chains as well.
And there is still plenty of skepticism on the Street. Analysts already aren’t expecting any significant turnaround at the company this spring. They now are banking their hopes on back-to-school and holiday 2002.
“There is no meaningful evidence that the two big brands — Gap and Old Navy — have improved their merchandising and marketing positions,” Lazard Freres analyst Todd Slater said.
Moody’s said the outlook for the senior unsecured long-term rating is negative and that the downgrade reflected performances at three of the retailers’ brands — Gap, Banana Republic and Old Navy. Each continues to experience negative comparable-store sales and lower profitability, despite initiatives to improve assortments and advertising campaigns and control expenses better.
S&P lowered Gap’s long-term corporate credit rating three notches to “BB-plus,” its highest junk grade, from “BBB-plus.” S&P also lowered its short-term credit rating to “B,” a junk grade, from “A-2.” S&P’s rating outlook is now stable.
When credit ratings are lowered, it typically becomes more expensive to borrow money. Although Gap now faces tougher negotiations with the banks and will have to borrow from banks on a secured basis, no one on the Street is predicting it will become the next big retailer, after Kmart Corp., to march into bankruptcy court. Analysts said the recent downgrades reflect the anxiety on the part of rating agencies. “It is a case of ‘Enron-itis’ and coming close to the Kmart filing,” UBS Warburg analyst Richard Jaffe said, who added that he agreed with the downgrade, but questioned its severity. “Gap has made better progress on the balance sheet than this downgrade reflects,” Jaffe said. “Give the Gap a little credit.”
For the past year, Gap has taken tough measures to improve its balance sheet. Among the most significant steps were reducing store growth plans to 5 percent this year from 30 percent in 2000. Expenditures were further reduced by cutting inventory levels.
Some of the fine-tuning is beginning to bear fruit. On Feb. 7, when releasing its January comp-store results, Gap said it expects to end the fourth quarter with a cash position of more than $800 million and a total debt of about $2 billion, below the previous guidance of $2.2 billion. In addition, capital expenditures are expected to be about $1 billion for 2001 and about $400 million for 2002, which is well below initial guidance of $600 million to $650 million.
Although Gap has said it sees its spring line as the first of many steps in its revival, retail watchdogs have indicated that the stakes are becoming increasingly high. “If Gap does not deliver by Christmas, all bets are off,” Slater said.