TEXT-S&P rates Ruby Tuesday's notes 'B-'
Overview -- U.S. casual-dining restaurant chain operator Ruby Tuesday has completed a refinancing transaction, adding a new $250 million senior note to repay existing debt. -- Concurrently, the company amended its existing revolver, reducing total commitments to $200 million from $380 million. -- After receiving final documents and reviewing the terms, we are assigning our 'B' corporate credit rating to Ruby Tuesday and our 'B-' issue-level rating and '5' recovery rating to its $250 million senior notes. -- The stable outlook reflects our belief that credit protection metrics will remain in line with expectations despite operational erosion that could result in weakening credit measures over the intermediate term. Rating Action On July 19, 2012, Standard & Poor's Ratings Services assigned its 'B' corporate credit rating to Maryville, Tenn.-based Ruby Tuesday Inc. The outlook is stable. At the same time, we assigned a 'B-' issue-level rating with a '5' recovery rating to the company's $250 million senior unsecured notes. The '5' recovery rating indicates our expectation for modest (10% to 30%) recovery of principal in the event of a payment default. Ruby Tuesday used the proceeds from the notes mainly to repay $155 million in existing revolver borrowings, about $45 million in existing senior notes, and nearly $20 million in mortgage-related debt. The company could use the proceeds in the future to fund share repurchases and other acquisitions. Rationale The rating on Ruby Tuesday reflects Standard & Poor's expectation that credit metrics will continue to weaken in the near term. While the transaction added only modest leverage, we expect operating performance will decline in the coming year because of continued top-line erosion and increased costs associated with the company adjusting its strategy to reposition itself in the saturated bar-and-grill category within the restaurant industry. We view Ruby Tuesday's financial risk profile as "highly leveraged" because the refinancing adds debt at a time when the company is seeking to restore consistently positive sales through menu and pricing changes. Ruby Tuesday is increasing leverage from 4.4x in the third quarter ended Feb. 28, 2012 to 4.6x pro forma for the deal. Pro forma debt includes the $250 million notes and nearly $90 million in mortgage-related liabilities largely acquired as part of the company's franchise partnership acquisitions in fiscal 2011. Interest coverage will decline to an estimated 2.7x from 3.4x before the transaction. Below is our financial ratio forecast for fiscal year-end 2013 (May 2013): -- We expect Ruby Tuesday's leverage will reach 5.8x due to a decline in EBITDA. -- We believe EBITDA interest coverage will decline to 2.2x because of performance erosion and higher costs associated with the re-financing. -- We forecast funds from operations (FFO) to debt will decline to 13.2% in 2013 from the low-20% range before the deal as a result of operational weakness and added leverage. The outlook for the casual-dining sector remains negative due to oversupply, lack of differentiation, and declining traffic. The sector is highly competitive with respect to prices and service and has seen increased media spending to support new promotions in recent years. We view Ruby Tuesday's business risk profile as "vulnerable," reflecting its lack of brand diversity to date and weak market position relative to peers, which have seen stronger turnarounds recently because of their promotional efforts. We forecast Ruby Tuesday could continue to lose market share in the near term to larger peers including Darden Restaurants Inc. and Brinker International Inc., which both posted positive same-store sales in the latest quarter, while Ruby Tuesday delivered negative results. We expect a 10% EBITDA decline for the fiscal year ending May 2013, as continued closures of Ruby Tuesday restaurants offset incremental sales from new concepts. We also expect the company's EBITDA margin will decline 70 basis points (bps) to 6.5% in 2013 as increased marketing and other spending to support its repositioning offset procurement and other cost savings. We believe future growth will be limited for Ruby Tuesday, stemming from converting less profitable existing restaurants into new concepts, including seafood restaurant Marlin and Ray's. Standard & Poor's economists currently forecast a 20% likelihood of a U.S. recession, with GDP growing 1.9% in the second half of 2012 and 2.1% in 2013, unemployment continuing to remain at or above 8%, and consumer spending growing 2.2% in 2012 and 2.4% in 2013. Considering these economic assumptions, our forecast for Ruby Tuesday's operating performance for fiscal 2013 includes the following: -- We expect overall sales will be flat as the company closes existing Ruby Tuesday restaurants or converts them into new concepts including Marlin & Ray's, for a net 4% decline in total restaurant count. -- We believe gross margin will decrease 20 bps due to elevated commodity costs and increased promotions. -- We anticipate total selling, general & administrative (SG&A) expenses will increase in the low-single-digit percent rate due to incremental TV and other advertising costs. -- We project modest franchise buy backs of 15 to 20 restaurants in the U.S. -- We forecast a 31% EBITDA decline in fiscal 2012 and 10% decline in 2013 as continued closures of Ruby Tuesday restaurants outweigh modest new profit from new and converted stores. Ruby Tuesday cut capital spending and labor costs amid the economic downturn, eventually closing underperforming restaurants to improve profitability. Despite weak top-line results, the company generated strong free cash flow of more than $120 million in 2010 due to reduced spending and one-time items. Fiscal 2011 was the first year of positive top-line results since 2007 but free cash flow declined to $90 million due to higher costs associated with acquiring franchise partnerships and renovating existing Ruby Tuesday restaurants. We project free cash flow will continue to decline in fiscal 2013 and are forecasting a 60% decrease to about $37 million due to increased capital spending and lower earnings. In particular, we believe operating leverage will continue to worsen as Ruby Tuesday absorbs costs associated with its franchise partnerships and increases marketing spending. We expect Ruby Tuesday will generate between $25 million and $50 million from continued sale leasebacks in the coming year and could spend as much as $20 million on share repurchases annually if cash flow improves. We project the company will also continue to generate lower average unit volumes than some peers as it converts its Ruby Tuesday restaurants into new concepts. Liquidity We view Ruby Tuesday's liquidity as "adequate," as we expect its sources of liquidity to be greater than its uses over the next 12 to 18 months. The amended revolver included in this transaction provides more flexible covenants, which will provide a cushion for projected weak near-term performance. Our assessment of the company's liquidity profile includes the following factors and assumptions: -- We forecast cash sources will exceed cash uses by more than 1.2x over the next 12 months and remain positive over the next 24 months. -- We forecast net sources would remain positive even if EBITDA were to decline 15%. -- We expect the company will continue to borrow under the revolver in the near term to fund capital expenditures and other costs associated with restaurant conversions. -- Debt maturities are favorable, with the revolving credit facility due in 2015 and senior notes due in 2020. Recovery analysis For the complete recovery analysis, see the recovery report on Ruby Tuesday, to be published as soon as possible on RatingsDirect. Outlook The stable rating outlook reflects our expectation that operational deterioration, coupled with limited debt reduction, will result in worse credit measures over the intermediate term. We could lower the rating if debt leverage approaches 7x and FFO to total debt declined below 10%. This could occur if gross margin falls 150 bps and EBITDA declines about 25% from our expectations for fiscal 2013. It could also occur if SG&A grows at a mid-single-digit percent rate compared to the current low-single-digit rate we are forecasting. Given Ruby Tuesday's expected credit measures, our industry outlook and continued restaurant closures and conversions, we are not expecting to raise our ratings over the near term. Related Criteria And Research -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Criteria Guidelines For Recovery Ratings On Global Industrials Issuers' Speculative-Grade Debt, Aug. 10, 2009 -- Key Credit Factors: Business And Financial Risks In The Restaurant Industry, Dec. 4, 2008 Ratings List New Ratings Ruby Tuesday Inc. Corporate Credit Rating B/Stable/-- Senior Unsecured US$250 mil 7.625% sr nts due 2020 B- Recovery Rating 5 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.