TEXT-S&P revises Jo-Ann Stores outlook to positive

Thu Apr 12, 2012 11:40am EDT

April 12 - Overview	
     -- U.S. fabrics and crafts retailer Jo-Ann Stores Inc.'s financial ratios 	
improved last year from sales growth and margin expansion.	
     -- We are affirming all ratings, including the company's 'B' corporate 	
credit rating, and revising the outlook to positive from stable.	
     -- The positive outlook reflects our expectation that recent financial 	
ratio improvement can continue even in a low-growth economy, with the 	
possibility for ratios to reach levels indicative of an aggressive financial 	
risk profile within the next 12 months.	
 	
Rating Action	
On April 12, 2012, Standard & Poor's Ratings Services affirmed its 'B' 	
corporate credit rating on Hudson, Ohio-based Jo-Ann Stores Inc. and revised 	
the outlook to positive from stable.	
	
At the same time, we affirmed the 'B+' (one notch above the corporate credit 	
rating) issue-level rating on the company's $650 million senior secured term 	
loan B facility due 2018. The recovery rating is '2', indicating our 	
expectation of substantial (70% to 90%) recovery for lenders in the event of a 	
payment default. We also affirmed the 'CCC+' (two notches below the corporate 	
credit rating) issue-level rating on the company's $450 million senior 	
unsecured notes due 2019. The recovery rating is '6', indicating our 	
expectation of negligible (0% to 10%) recovery for note holders in the event 	
of a payment default. 	
 	
Rationale	
The rating action reflects Standard & Poor's Ratings Services' forecast that 	
Jo-Ann Stores Inc.'s recent financial ratio improvement from sales growth and 	
margin expansion can continue, even in a low-growth economy.	
	
The ratings on Jo-Ann Stores reflect Standard & Poor's business risk profile 	
assessment of "weak" and its financial risk profile assessment of "highly 	
leveraged." Our business risk assessment reflects our analysis that continued 	
capital investment in store enhancement is necessary to maintain its 	
competitive position. It also reflects the company's participation in the 	
competitive and highly fragmented craft and hobby retail industry, as well as 	
the seasonal nature of its earnings. Our financial risk assessment reflects 	
our expectation for financial policies to remain very aggressive under 	
financial sponsor ownership. It also reflects our forecast for financial 	
ratios to remain indicative of a highly leveraged financial risk profile this 	
year, but to possibly reach levels indicative of an aggressive financial risk 	
profile within the next 12 months. Below is our financial ratio forecast for 	
fiscal year-end January 2013 and for fiscal year-end January 2014, 	
respectively:	
     -- Operating lease-adjusted total debt to EBITDA decreases to 5.6x and 	
then decreases to 5.2x, primarily from profit growth.	
     -- Funds from operations (FFO) to total debt increases to about 15% and 	
then increases to nearly 16%, primarily from profit growth.	
     -- EBITDA coverage of interest increases to 2.5x and then increases to 	
2.7x, primarily from profit growth.	
 	
Principal economic factors we considered in our company forecast include weak 	
economic growth, high unemployment, weak consumer spending growth, and 	
elevated raw material costs through 2013. More specifically, Standard & Poor's 	
economists currently forecast GDP growth of 2.1% in 2012 and 2.3% in 2013, 	
consumer spending growth of 2.0% in 2012 and 2013, the unemployment rate 	
remaining at or above 8% through 2013, and crude oil per barrel (WTI) 	
finishing 2012 near $105 and finishing 2013 near $115. We currently estimate 	
there is a 20% probability of a recession occurring in the U.S. Considering 	
these economic forecast items, our forecast for the company's operating 	
performance is as follows:	
     -- Revenue growth in the mid- to high-single-digit percent area, boosted 	
by an extra week in fiscal 2013 and the company's plan to continue adding new 	
stores and remodeling existing ones.	
     -- Gross margin is flat to slightly higher, as elevated input costs 	
continue to offset modest gains from private-label and direct sourcing 	
initiatives.	
     -- Operating expenses grow at a lower rate than revenue, with growth 	
principally from store development initiatives.	
     -- Debt repayment is limited to contractual debt amortization plus excess 	
cash flow payment to be paid in the fiscal 2013 first quarter, based on fiscal 	
2012 results.	
 	
We view the company's financial policies to be very aggressive, primarily 	
because of the majority equity ownership by the financial sponsor, Leonard 	
Green & Partners L.P. Our view incorporates our expectation for the company to 	
deploy excess cash for capital investments, and possibly dividends, as opposed 	
to accelerated debt repayment, given the typical transient nature of financial 	
sponsor ownership. Leonard Green took Jo-Ann Stores private through a 	
leveraged buyout in March 2011.	
	
Our business risk assessment incorporates our opinion that the industry will 	
remain competitive and highly fragmented. We believe the top three companies 	
control about one-third of industry share, with Jo-Ann Stores trailing behind 	
Michaels Stores and Hobby Lobby. We believe these three companies will 	
continue to invest in store expansion to gain industry share. New store 	
expansion will continue to contribute to growth.	
	
Jo-Ann is highly dependent on discretionary consumer spending, and we believe 	
the company relies on a loyal, yet narrow base of repeat customers for growth. 	
For same-store sales growth to consistently exceed GDP growth, the company 	
will need to expand its customer base and broaden its customer profile, likely 	
through targeted marketing campaigns via multiple channels. We believe such 	
initiatives are underway, but it is still too early to gauge the potential 	
benefits.	
	
There is significant seasonality in the company's business. The majority of 	
sales take place in the third and, to a greater extent, fourth quarter. 	
Heightening this risk is the long ordering lead times the company's suppliers 	
require. For example, it typically orders holiday season merchandise in 	
February or March. As such, misjudging consumer preference or demand could 	
materially harm financial results.	
	
We believe the company will be able to continue to benefit from operating 	
expense leverage, though not to the extent it achieved in recent years. An 	
enhanced store base and increased direct sourcing of products has helped 	
profitability. We calculate gross margin has improved nearly 350 basis points 	
since fiscal 2007, and we believe increased direct product sourcing 	
contributed meaningfully to this improvement. The company has also efficiently 	
managed its operating expenses. Since fiscal year 2007, operating expenses 	
have increased at a compound annual growth rate (CAGR) of less than 1.5%, 	
while revenue has increased at a CAGR of about 3.5%. 	
 	
Liquidity	
We believe Jo-Ann Stores has adequate liquidity, and we expect cash sources to 	
exceed cash uses over the next 24 months. Cash sources primarily include 	
surplus cash, funds from operations, and revolver availability. Cash uses 	
primarily include working capital, capital expenditures, and debt 	
amortization. Our liquidity assessment includes the following factors, 	
expectations, and assumptions:	
     -- We forecast cash sources to exceed cash uses by more than 1.2x over 	
the next 12 months and to remain positive over the next 24 months.	
     -- We forecast net sources would remain positive even if EBITDA were to 	
decline 15%.	
     -- We believe the company will maintain excess availability under its 	
revolving credit facility so that no material financial ratio maintenance 	
covenants would apply.	
     -- Contractual debt amortization is low, at $6.5 million per year.	
     -- Debt maturities are favorable, with the revolving credit facility due 	
in 2016, the term loan due in 2018, and the senior notes due in 2019.	
     -- As of Jan. 28, 2012, we calculate total liquidity of about $350 	
million, with revolver availability of about $280 million.	
 	
Recovery analysis	
For the complete recovery analysis, please see the recovery report on Jo-Ann 	
Stores, to be published on RatingsDirect following this report.	
 	
Outlook	
Our positive rating outlook reflects our expectation that recent financial 	
ratio improvement can continue even in a low-growth economy, with the 	
possibility for ratios to reach levels that indicate an aggressive financial 	
risk profile within the next 12 months.	
	
We could raise our ratings if positive operating performance trends continue 	
and it becomes clear that financial ratios will improve to levels indicating 	
an aggressive financial risk profile, including operating lease-adjusted total 	
debt to EBITDA reaching the low-5x area and funds from operations to total 	
debt exceeding 15%. Based on last fiscal year's fourth-quarter results, EBITDA 	
would have to increase nearly 20% for leverage to reach the low-5x area and 	
FFO would have to increase about 15% for FFO to total debt to exceed 15%.	
	
We could revise our outlook to stable if positive operating performance trends 	
reverse, causing financial ratio improvement to stall or worsen and leading us 	
to revise our forecast to reflect financial ratios remaining firmly within 	
levels indicative of a highly leveraged financial risk profile, including 	
operating lease-adjusted total debt to EBITDA remaining near 6x and FFO to 	
total debt decreasing to about 12%. Based on last fiscal year's fourth-quarter 	
results, EBITDA growth would have to remain flat for leverage of about 6.0x 	
and FFO would have to decrease 9% for FFO to total debt of about 12%.	
 	
Related Criteria And Research	
     -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011	
     -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009	
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008	
 	
Ratings List	
	
Ratings Affirmed; Outlook Action	
                                        To                 From	
Jo-Ann Stores Inc.	
 Corporate Credit Rating                B/Positive/--      B/Stable/--	
	
Ratings Affirmed; Recovery Ratings Unchanged	
	
Jo-Ann Stores Inc.	
 Senior Secured                         B+                 	
  Recovery Rating                       2             	
 Senior Unsecured                       CCC+       	
  Recovery Rating                       6             	
	
	
Complete ratings information is available to subscribers of RatingsDirect on 	
the Global Credit Portal at www.globalcreditportal.com. All ratings affected 	
by this rating action can be found on Standard & Poor's public Web site at 	
www.standardandpoors.com. Use the Ratings search box located in the left 	
column.
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