New York, September 12, 2022 — Moody’s Investors Service (“Moody’s”) downgraded pH Beauty Holdings III, Inc.’s (pH Beauty) Corporate Family Rating (CFR) to Caa2 from Caa1, and its Probability of Default Rating to Caa2-PD from Caa1-PD. Moody’s also downgraded the company’s senior secured first lien credit facility to Caa1 from B3, and its senior secured second lien term loan to Ca from Caa3. The rating outlook is negative.
The downgrades reflect Moody’s view that pH Beauty’s high financial leverage, weak liquidity and negative free cash flow are increasing the risk of default including a distressed exchange as the company seeks to address upcoming maturities starting with the September 2023 revolver expiration. pH Beauty’s earnings have sharply declined as a result of supply chain disruptions and elevated freight costs, which are expected to remain high in 2023. The company’s liquidity has significantly deteriorated as earnings decline and heavy spending on building inventory to improve customer fill rates lead to negative free cash flow. The company’s liquidity is further pressured by increasing cash interest costs from rising interest rates, as all of its debt are floating, and limited cushion under the maximum total net leverage covenant that steps down in December 2022. Although consumer demand is reasonably stable, Moody’s believes the company’s products are largely in discretionary categories such as cosmetic accessories, sunless tanning treatments, and bath accessories that could experience some consumer pullback in the current inflationary environment. This along with challenges raising prices in competitive categories will make it difficult to meaningfully increase EBITDA if freight costs do not fall materially. Moody’s is concerned that the nearing September 2023 revolver expiration with a $18 million outstanding balance as of June 2022 may not afford the company enough time to stabilize earnings and strengthen credit metrics enough to permit a successful refinancing of the debt. Moody’s thus views default risk as growing including the potential for a distressed exchange transaction such as a discounted debt repurchase.
The following ratings/assessments are affected by today’s action:
Ratings Downgraded:
..Issuer: pH Beauty Holdings III, Inc.
…. Corporate Family Rating, Downgraded to Caa2 from Caa1
…. Probability of Default Rating, Downgraded to Caa2-PD from Caa1-PD
….Senior Secured 1st Lien Bank Credit Facility (Revolver and Term Loan), Downgraded to Caa1 (LGD3) from B3 (LGD3)
….Senior Secured 2nd Lien Bank Credit Facility, Downgraded to Ca (LGD5) from Caa3 (LGD5)
Outlook Actions:
..Issuer: pH Beauty Holdings III, Inc.
….Outlook, Changed To Negative From Stable
RATINGS RATIONALE
The Caa2 CFR reflects pH Beauty’s small scale and weak credit metrics including a very high debt-to-EBITDA leverage at above 15x and over $30 million negative free cash flow for the twelve-month ending June 30, 2022. Earnings erosion in the last 18 months is contributing to the high leverage with supply chain disruptions and heightened freight costs, with free cash flow additionally weakened by building inventory. pH Beauty does not have its own manufacturing facilities and imports the majority of its products from China. Although Moody’s expects demand for beauty products to remain solid as consumers increase outdoor activities, Moody’s views pH Beauty’s products as more discretionary than other beauty categories such as skincare and color cosmetics. Consumers are more likely to cut spending on beauty tools/accessories such as makeup brushes, as well as spending on sunless tanning products and bath accessories in an economic downturn. Moreover, the cosmetic accessories and facial skin care industries are highly competitive with many branded product companies that are significantly larger, more diverse, financially stronger, and which have much greater investment capacity. Moody’s believes pH Beauty’s default risk has increased as a result of continued heightened costs and weak liquidity, including a very thin cushion under its net leverage maintenance covenant and the nearing September 2023 revolver expiration with a $18 million outstanding balance as of June 2022. pH Beauty’s rating is supported by the company’s strong brand name recognition in niche markets, recovering demand in beauty and cosmetics, and the company’s recent category expansion to skincare.
pH Beauty’s exposure to environmental risks is moderately negative (E-3). Waste and pollution risks are moderately negative reflecting the waste created from packaging material that often cannot be recycled. The company has neutral-to-low exposure to physical climate risks, carbon transition, water management, and use of natural capital risks.
pH Beauty’s exposure to social risks is moderately negative (S-3). The company’s exposure to customer relations is moderately negative given the company is consumer facing with investment in product innovation, quality and marketing necessary to sustain the market position. Responsible production risk is moderately negative because the company must cost-effectively manage its supply chain, responsibly source inputs, and continue to invest to limit exposure to risks related to product labeling, marketing, recalls, and contamination. The company has neutral-to-low risk exposure to demographic and societal trends, human capital, and health and safety.
pH Beauty has highly negative governance risk (G-4) primarily due to aggressive financial policies under the company’s private equity ownership and its high leverage that is in part due to debt financed acquisitions. The company has been owned by Yellow Wood Partners since 2017. Concentrated decision making creates potential for event risk and decisions that favor shareholders over creditors.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
The negative outlook reflects Moody’s view that pH Beauty’s capital structure is increasingly unsustainable with very high leverage and negative cash flow generation. The depressed earnings as a result of significant freight costs coupled with weak liquidity elevate the company’s refinancing and default risks.
The ratings could be downgraded if the company is unable to improve EBITDA due to cost pressures such as elevated freight costs and product procurement, or demand for the company’s products weakens. Ratings could also be downgrade if pH Beauty’s liquidity weakens, the company is unable to proactively address its 2023 maturity, the risk of a debt restructuring or event of default increases for any reason, or if recovery prospects weaken.
The ratings could be upgraded if leverage materially declines driven by improved operating results, the company can sustainably generated positive free cash flow and liquidity improves including successfully addressing the September 2023 expiration of its revolving credit facility.
The principal methodology used in these ratings was Consumer Packaged Goods published in June 2022 and available at https://ratings.moodys.com/api/rmc-documents/389866. Alternatively, please see the Rating Methodologies page on https://ratings.moodys.com for a copy of this methodology.
pH Beauty is a designer of cosmetic accessories, bath accessories, sunless tanning and facial skin care products. Key brands include Real Techniques, EcoTools, Freeman, Tan-luxe, Isle of Paradise, Tanologist, and BYOMA. Yellow Wood Partners acquired the company in 2017. pH Beauty generates roughly $300 million in annual revenues.
REGULATORY DISCLOSURES
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Dawei Ma
Analyst
Corporate Finance Group
Moody’s Investors Service, Inc.
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John E. Puchalla, CFA
Associate Managing Director
Corporate Finance Group
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