Strategic owner Henry Schein recently increased its ownership in Butler Animal Health to 71.5%. Butler aligns well with Henry Schein's strategic growth objective of expanding its animal health business. We believe Henry Schein has considerably stronger financial resources than Butler Animal Health. Henry Schein's increased ownership stake in Butler, and stronger financial resources, contributed to our one-notch increase in Butler's corporate credit rating in January 2012.
We believe that, on a standalone basis, Butler Animal Health Supply has a weak business risk profile. This primarily reflects its susceptibility to economic cycles and consumer spending, offset by good market share. Despite the often strong emotional bond between owners and companion pet animals that would suggest stable revenues, a weak economy and high unemployment pressure sales. As consumer discretionary income declined, consumers reduced veterinary spending. Although recent quarters suggest some organic improvement, aided by small technology acquisitions, any economic instability could hinder further growth. As a result, we believe that Butler will generate only mid-single-digit revenue growth and flat to slightly higher margins in 2012.
Butler is one of only a few national distributors and, with an industry-leading 26% market share in animal health distribution, has operating scale. Henry Schein, as a much larger majority and strategic owner, can provide additional operating scale and economies of scale. While Butler alone has access to suppliers that some of its smaller regional competitors lack, it will still be challenged to implement price increases, or pass through higher supplier prices, given continued competition from those regional and local distributors and a still-challenging economy with high unemployment.
We believe Butler's liquidity will be "adequate" (as defined in our criteria) to cover its needs over the next 12 to 24 months. Our assessment of the company's liquidity profile includes the following expectations, assumptions, and factors:
-- Sources of liquidity at March 31, 2012 included about $4.8 million of cash on hand and more than $20 million of FFO in the first quarter of 2012, on track to exceed our expectation of more than $60 million of FFO in 2012.
-- Full availability of its $50 million revolving credit facility, and $7.7 million available through Henry Schein's cash pool facility.
-- We expect uses of cash to include some investment in working capital; relatively low capital expenditures of no more than $5 million per year provide flexibility.
-- Aggressive step-downs in the covenant cushion and our expectation of flat margins could erode the leverage covenant cushion to 15% by the end of 2012.
The issue-level rating on Butler's $366 million senior secured credit facility is 'BB' (the same as the corporate credit rating) with a '3' recovery rating. The credit facility includes a $50 million revolving credit facility due Dec. 31, 2014; a $216 million term loan B due Dec. 31, 2015; and a $100 million term loan A due Dec. 31, 2014. The '3' recovery rating indicates our expectation for meaningful (50%-70%) recovery in the event of payment default. (For the complete recovery analysis, see the recovery report on Butler Animal Health Supply LLC, published Jan. 24, 2012, on RatingsDirect.)
Our stable rating outlook on Butler reflects our expectation that a still-weak, but stable, economy will result in mid-single-digit revenue growth and flat EBITDA margins. This supports our belief that, although Butler has an aggressive step-down structure for its leverage covenant, it should be able to sustain an adequate covenant cushion of about 15% over the near term.
We could lower our rating in the unlikely scenario where another economic recession occurs that causes a liquidity event, such as an imminent covenant breach, and there is no financial support from Henry Schein. We could raise the rating if the economy improves faster than we expect, enabling more rapid debt reduction and/or EBITDA growth that results in Butler growing its covenant cushion to 20% or more through the multiple step-downs over the next four quarters.
Related Criteria And Research
-- Methodology And Assumptions: 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