DBRS Downgrades Golf Town Canada Inc. & Golfsmith International Holdings Inc. to B and CCC (high), Trend Changed to Negative

DBRS has today downgraded the Issuer Rating of Golf Town Canada Inc. & Golfsmith International Holdings, Inc. (collectively Golfsmith or the Company) to B from B (high) and the Senior Secured Second Lien notes to CCC (high) from B (low), with a recovery rating of RR-6. The trends have also been changed to Negative from Stable. The downgrade reflects continued weakness in the Company’s sales and earnings, as well as material uncertainty surrounding the Company’s future earnings and profitability, which remain well below DBRS expectations at the time of their merger in 2012. The Negative trend reflects DBRS’s concerns over near-term liquidity, as well as the Company’s ability to return earnings and credit metrics to levels considered acceptable for the current B Issuer Rating. The ratings continue to reflect the discretionary and cyclical nature of the golf retail business, intense competition, sensitivity to weather and risks surrounding longer-term profitability and growth. The ratings are supported by the Company’s well-established market position, differentiating full-service format, geographic diversification across North America and sponsorship from OMERS.

Following a difficult 2013, where EBITDA was below DBRS expectations of $50 million, primarily due to poor weather conditions in many regions of North America, the Company’s earnings declined further in H1 2014. This was the result of harsh winter weather and another delayed start to the golf season, lower prices due to intense competition and discounting as a response to high industry-wide inventory levels, a lack of new manufacturer product introductions, the declining foreign exchange value of the Canadian dollar and post-merger integration issues in Canada.

In July 2014, Golfsmith undertook a comprehensive business review process in response to the mounting pressure on its operating performance. The review process included identifying initiatives to help reverse negative sales trends; reduce operating costs (in central support and in other selling, general and administrative (SG&A) considered condition-specific); optimize real estate portfolio renewals, including possible store closures, as a substantial portion (nearly one-third) of the Company’s leased real estate portfolio matures within three years; and an immediate reduction in capex and efforts to manage liquidity in the difficult operating environment.

Going forward, DBRS believes that a meaningful recovery in Golfsmith’s earnings profile will remain challenging, as the Company is expected to continue to face intense competition and declining golf participation rates. Golfsmith’s earnings could stabilize in the near term if weather conditions normalize through the winter and spring of 2015 and benefit in the longer term if industry rationalization allows Golfsmith to gain market share. DBRS believes that revenues will continue to decline modestly through the end of 2014, but should recover somewhat and increase in the mid-single-digit range in 2015. The increase in sales in 2015 is expected to be based on low-single-digit same-store sales growth and mid-single-digit growth in the Company’s direct-to-consumer and APG businesses, combined with a modest decline in store count. Adjusted EBITDA margins should remain pressured in the near term due to the industry-wide inventory position, but should rebound somewhat as inventory levels and discounting normalize. EBITDA margins should also benefit from the Company’s continued implementation of its strategic initiatives to drive sales and reduce costs. EBITDA should therefore remain at current low levels through the end of 2014, but should begin to improve over the medium term. EBITDA, however, is expected to remain well below previous forecasts in the $50 million range over the medium term.

Despite the recent strategic review and the resulting capital conserving measures undertaken by Golfsmith, the Company’s ratings will remain under pressure until it displays sustainable growth in operating income and cash flow, alleviating any liquidity concerns. Cash flow from operations should recover somewhat with improved operating performance in 2015. Working capital and capex requirements are expected to decline at least temporarily due to the Company’s recent capital conserving measures aimed at better controlling inventory positions and putting on hold all new uncomitted store openings. Capex should decline toward maintenance capex levels in 2015 as new store openings are put on hold. The Company is expected to continue to fund free cash flow deficits with borrowings on its ABL facility in the near term, as well as potential financing from OMERS if necessary. Over the longer term, DBRS expects any free cash flow generated will be used to repay ABL revolver debt. This, combined with any growth in earnings, could result in improved credit metrics and may lead to the trend being changed to Stable from Negative. However, should Golfsmith not be successful in managing any near-term liquidity concerns, as well as improving its credit risk profile in terms of same-store sales, operating income and key credit metrics, a further negative rating action could result.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The applicable methodology is Rating Companies in the Merchandising Industry, which can be found on our website under Methodologies.

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