Credit spreads of Gap Inc may be prone to further widening as the clothing retailer grapples with falling sales and the possibility of being downgraded into the high-yield universe. However, opinion is divided over whether the company is a likely candidate to be taken private in a leveraged buyout.
Gap's credit default swaps widened around 24 basis points this week to about 132 basis points on Friday, or $132,000 per year for five years to insure $10 million in debt, on speculation the company is ripe for an LBO.
Spreads also have weakened since Gap said on Thursday that sales at stores open at least a year fell 8 percent in November, and that it expects merchandise margin declines to continue into December, since revamped stores and merchandise have failed to attract shoppers. "Although management has worked hard at improving merchandise at all of the company's brands and at launching marketing campaigns over the past year, GPS has yet to achieve its greatest and most difficult task, regaining its customer base," CreditSights analysts said in a report.
"With its largest businesses, Old Navy and Gap still deteriorating, we believe a turnaround is out of the picture in the near term," they said.
"Despite the profit declines, GPS still maintains strong free cash flow and carries just $514 million in total debt," CreditSights said. "At the same time, these attributes have the markings of a solid LBO candidate."
Standard & Poor's cut Gap into junk territory on November 17, citing the company's disappointing sales and falling profits. Moody's Investors Service and Fitch Ratings both rank the company at their lowest investment grade ratings with a negative outlook, indicating a cut to junk is likely over the next one to two years. Gap will be under the microscope for its performance this holiday season, and if sales continue to disappoint it is likely the company will be cut to junk, said another analyst who declined to be named.