OREANDA-NEWS. S&P Global Ratings today said it has lowered its long-term corporate credit rating on Novartex S. A.S., the parent company of France-based mass-market apparel and footwear retailer Vivarte Group, to 'CCC' from 'CCC+'. The outlook is negative.

At the same time, we lowered our issue rating on the €500 million super senior bonds issued by subsidiary Vivarte to 'CCC' from 'CCC+'. The recovery rating on these notes is '3', reflecting our expectation of meaningful (50%-70%) recovery for creditors in the event of a default.

We also lowered our issue rating on the €780 million senior reinstated debt issued by Novarte to 'CC' from 'CCC-'. The recovery rating on these notes is '6', reflecting our expectation of negligible (0%-10%) recovery for creditors in the event of a default.

The downgrade reflects our view that, without an unforeseen positive development, Vivarte Group is likely to announce a distressed exchange or other debt restructuring in the next 12 months.

The company recently announced that it has appointed a special mediator (mandataire ad hoc), Helene Bourbouloux, to seek an agreement between the company and its lenders and shareholders in order to address the long-term sustainability of its capital structure. For the moment, the company has not released any further details about its intentions or actions regarding its capital structure.

On a S&P Global Ratings-adjusted basis, Vivarte Group's capital structure includes, alongside the senior debt, €800 million of convertible bonds ("obligations remboursables en actions" or ORA) and €451 million of operating-lease adjustments. We believe that lease-adjusted ratios tend to significantly understate the group's leverage, given the short-term nature of the group's operating leases. We therefore base our analysis on other ratios, such as reported debt to EBITDA, which better reflects the highly leveraged nature of Vivarte Group's financial risk profile. The reported gross-debt-to-last-12-months' EBITDA ratio was about 30x at the end of August 2015, including ORA (19x excluding ORA).

Given the divergent objectives of the €500 million super-senior bond holders and the holders of the €780 million reinstated senior debt--who are also the company's shareholders--we believe that a distressed exchange or other debt restructuring appears likely within 12 months, absent an unforeseen favorable development. We would consider such debt restructuring as a default. At the same time, we do not consider such a development as inevitable due to the absence of short-term debt maturities and modest cash interest expense.

Vivarte's operating performance is weak and we expect it to remain this way. Soft trading in footwear and apparel markets in France and a decline in full-price sales in the product mix have resulted in profitability and cash generation weakening further. We believe that reported free operating cash flow will continue to be strongly negative over the near term, as evidenced by the €240 million outflow in the nine months to May 2016, which compares to the €256 million outflow posted for the financial year to August 2015.

Our base-case scenario assumes the following for Vivarte Group: Already weak credit measures (adjusted debt to EBITDA of about 10x and funds from operations to debt of about 3.5% at Aug. 31, 2015) to deteriorate further through the balance of 2016 and into 2017 due to lower EBITDA. An inability to generate sufficient free cash flow to help pay down the company's debt or show signs of growth, thereby making it more difficult for Vivarte Group to refinance its debt maturing in 2019.

The negative outlook primarily reflects our view of the increased likelihood that Vivarte Group could undergo debt restructuring within the next 12 months as evidenced by its decision to appoint a special mediator in negotiations between the company, its lenders, and shareholders.

We would take a negative rating action if the company announces a distressed exchange, which we would likely view as tantamount to default. Likewise, we could lower the ratings if Vivarte Group faces higher short-term risk of a liquidity crisis.

Although we view it as unlikely in the next 12 months, an upgrade could result from a material improvement in operating performance, alleviating the risk of debt restructuring over a 12-month horizon and improving the propsects of timely refinancing and full repayment of the company's debt.