Fitch keeps Gap outlook negative

Fitch said the Gap, Inc.'s outlook remains negative and its senior unsecured debt remains at BB-.

The negative outlook reflects uncertainty as to the sustainability of Gap's recent comparable store sales growth.

The rating reflects the long-term weakness in Gap's sales which has put pressure on the company's operating and financial profile. In addition, the competitive operating and weak economic environment may delay the company's ability to improve its performance, Fitch noted.

However, the rating also factors in Gap's brand position, solid free cash flow due to curtailment in capital expenditures and strong liquidity.

From May 2000 through September 2002, Gap reported negative comparable store sales every month as a result of a troubled merchandising strategy. Some senior management changes, coupled with a significant slowdown in store expansion plans (which allowed the company to focus on its existing store base) and return to a more traditional, basic merchandise selection has led to an improvement in the company's sales trends more recently.

Each of Gap's three concepts, Gap, Banana Republic and Old Navy, have reported positive comparable store sales for the last six months. Though these results benefit from poor past performance, they indicate that Gap has begun to turnaround its sales trends.

However, Gap's ability to generate positive comparable store sales for a longer period of time, particularly when comparisons become more difficult or if the economy should further weaken, remains a concern, Fitch said.

At the same time, Gap significantly curtailed its capital spending and square footage growth. Square footage growth slowed to 3% in 2002, following annual increases ranging from 16%-31% over the prior five years. This led to a reduction in capital expenditures to about $300 million in 2002 from an average of $1.06 billion in the previous five-year period. As a result, cash flow increased dramatically in 2002, with cash flow from operating activities (before effect of exchange rate fluctuations on cash) less net capital expenditures growing to $947 million from about $367 million in fiscal 2001. In 2003, Gap is forecasting a decline in square footage of about 2% and modest capital spending of about $350-400 million, which should further enhance the company's free cash flow.

Strong cash flow generation, combined with proceeds from several debt offerings, significantly bolstered the company's cash balances and enhanced its liquidity. As of Feb. 1, 2003 Gap's cash balances totaled $3.338 billion, nearly equal to its total debt burden of $3.395 billion. On May 1, 2003 the company repaid $500 million of notes with cash on hand. Gap's $1.4 billion revolving credit facility remains undrawn, Fitch said.

Moody's downgrades Kansas City Southern, rates convertible B3

Moody's Investors Service downgraded Kansas City Southern including cutting its senior unsecured debt to Ba3 from Ba2 and assigned a B3 rating to its new $175 million redeemable cumulative convertible perpetual preferred stock. The outlook is negative.

Moody's said the downgrade is because of the underperformance of the railroad against expectations, Moody's expectation of poor financial results in the absence of a strong economic recovery, the high level of adjusted debt compared to KCS' cash flow, and the increased debt burden associated with funding the acquisition of Grupo TFM shares from Grupo TMM.

The ratings could be pressured down if KCS' railroad operations weaken further resulting in negative free cash flow, financial results fail to improve measurably in tandem with any recovery of the industrial markets, or the economics of the transaction to purchase the TFM shares change materially as a result of any regulatory conditions, extension of time to effect the closing, or any increase the purchase price.

Moody's noted in particular that the ratings could be further downgraded if the Government of Mexico does exercise its put for the 20% of TFM shares without an offset by resolution of the value added tax claim. This put would require KCS to raise very substantial additional capital to fund the purchase of the shares.

Moody' said it believes that the railway's cost structure is such that it is unlikely for the company to generate a meaningful amount of cash flow without a marked improvement in business volume from its industrial customers.

Even with a sustained recovery, KCS' operating ratio would need to be much lower than Moody's expectations for sufficient cash flow to materially reduce its debt. With limited non-core assets remaining to sell for cash, KCS is likely to have a relatively high adjusted debt level and weak credit metrics for some time.

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