Investing.com -- Moody’s Ratings has downgraded the corporate family rating (CFR) of Restoration Hardware, Inc. (RH (NYSE: RH )) to B3 from B1. The downgrade also includes the company’s probability of default rating (PDR), which has been revised to B3-PD from B1-PD. The ratings of the senior secured first lien term loan B and senior secured first lien term loan B2 were also downgraded to B3 from B1. The speculative grade liquidity rating (SGL) remains unchanged at SGL-3. Moody’s has revised the company’s outlook to stable from negative.

The downgrade comes as Moody’s expects RH’s credit metrics to remain weak due to a challenging consumer environment and cost pressures arising from higher tariffs, amidst uncertainty in US trade policy. In fiscal 2024, RH sourced 23% of its product from China and 35% from Vietnam, but the company aims to reduce its sourcing from China to zero by the second half of 2025. The company’s leverage is high, with a debt/EBITDA ratio of 6.5x and weak coverage with an EBITA/interest ratio of 1.4x for FY 2024. These credit metrics are expected to worsen over the next 12-18 months as higher import costs impact the company’s profitability.

Despite positive revenue trends starting in Q2 2024, Moody’s expects the current uncertainty to weigh on consumer demand. The SGL-3 rating indicates Moody’s expectation that RH will maintain at least breakeven cash flow as high inventories, which are up 35% from last year, reduce immediate sourcing needs. Moody’s also assumes that RH will extend its $600 million credit line before July 29, 2025, a year before its maturity. As of the end of Q4 2024, the company has a cash balance of $30 million, with $200 million drawn and an estimated net availability of $295 million under its credit line as of February 2, 2025.

The B3 CFR reflects the cyclical nature of the home furnishing industry and the company’s weak credit metrics. Over the next 12 to 18 months, the Debt/EBITDA is expected to trough at approximately 6.5x-7.5x with EBITA/interest of 1.1x-1.4x as the effect of tariffs begin to have a significant impact on earnings starting in the second half of 2025. The rating is also constrained by RH’s continued investments in international growth which are significant drag on its profitability. The rating is also constrained by its aggressive business and financial strategies. However, RH’s strong luxury brand, particularly in furniture, and the success of its existing Design Galleries, as evidenced by its historically solid operating margins, are positive for the ratings.

The stable outlook reflects Moody’s anticipation that the company will successfully adapt its operations to the changing US trade policy, including changes to its sourcing strategy, capital plans, pricing model, and cost structure. The stable outlook also reflects that Moody’s expects RH to maintain at least adequate liquidity, including positive free cash flow and the extension of its credit line before it becomes due.

The ratings could be downgraded if liquidity deteriorates for any reason, including if its credit line is not extended well before maturity, free cash flow turns negative or estimated recoveries become impaired. The ratings could also be downgraded if operating performance results in Moody’s adjusted debt/EBITDA sustained above 6.5x or EBITA/interest sustained below 1.0x. Any aggressive financial strategy, including share repurchase would be viewed negatively.

On the other hand, the ratings could be upgraded if the company demonstrates conservative financial strategies while maintaining good liquidity and consistent and improved operating performance. Quantitatively, the ratings could be upgraded if Moody’s adjusted debt/EBITDA is sustained below 5.5x and EBITA/interest is sustained above 1.75x.

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