TEXT-S&P keeps Sally Beauty rating unchanged after note add-on

Wed Sep 5, 2012 1:27pm EDT

Overview
     -- U. S. beauty supply distributor Sally Holdings LLC and Sally Capital 
Inc., as co-issuers, are proposing to issue $150 million of 5.75% senior 
unsecured notes due 2022. This is an add-on to the $700 million of 5.75% notes 
they issued on May 18, 2012. 
     -- Our 'BB+' issue-level rating and '3' recovery rating on the notes 
remain unchanged. 
     -- We are also affirming our 'BB+' corporate credit ratings on both Sally 
Holdings LLC and Sally Beauty Holdings Inc. 
     -- The outlook is positive, reflecting our view that Sally Beauty will 
maintain its positive operating momentum, resulting in improving credit 
metrics over the near term.

Rating Action
On Sept. 5, 2012, Standard & Poor's Ratings Services affirmed our 'BB+' 
corporate credit ratings on Denton, Texas-based Sally Beauty Holdings Inc. and 
Sally Holdings LLC. The outlook is positive.

We also kept our 'BB+' issue-level rating on Sally Holdings LLC and Sally 
Capital Inc.'s (as co-issuers) 5.75% senior unsecured notes due 2022 unchanged 
after the proposed $150 million add-on. This would represent a drawdown from 
the company's shelf registration. The recovery rating on this debt remains 
'3', indicating our expectation of meaningful (50% to 70%) recovery for 
noteholders in the event of a payment default.

Rationale
The ratings on Sally Beauty Holdings and its indirect wholly owned 
subsidiaries Sally Holdings and Sally Capital reflect Standard & Poor's 
opinion that Sally's financial risk profile is "significant" and its business 
risk profile is "satisfactory." 

We assess Sally's financial risk profile as significant, reflecting our belief 
that the company will at least maintain a moderately leveraged capital 
structure, predictable positive cash flow generation--given the fairly stable 
characteristics of its distribution business--and credit protection measures. 
In addition, we view the company's business risk profile as satisfactory, 
given its position as the largest U.S. beauty supply distributor in the U.S., 
somewhat countered by its participation in the competitive and very fragmented 
professional beauty supply industry, both domestically and internationally. We 
also factor in our expectation that Sally will make small tuck-in acquisitions 
and moderate share repurchases over the intermediate term, but that they will 
not be credit-damaging.

In our view, Sally has performed well since its spinoff from Alberto-Culver in 
2006. Indeed, the company has exceeded our expectations in terms of its 
operating performance through the recession and its debt reduction. Same-store 
sales continue an upward trend, rising 5.2% in the third quarter compared with 
5.9% in the prior year. We believe that the company will be able to sustain 
these trends over the next several years because of the stable, recurring 
nature of its business. We expect new store openings and small acquisitions to 
continue, like the recent acquisition of Kapperservice Floral B.V., the 
largest professional beauty supply group in the Netherlands, which the company 
funded primarily with free cash flow, to propel sales growth. 

Currently at about 3.2x, debt leverage has consistently improved because of 
EBITDA growth and debt repayment and EBITDA to interest coverage improved to 
4.4x as of June 30, 2012 as compared to 3.6x in the prior year. Over the next 
year, we estimate that credit ratios could be indicative of an "intermediate" 
financial risk profile. We project leverage will be below 3x, EBITDA interest 
coverage will improve to the low-5x area, and funds from operations (FFO) to 
total debt will be in the mid-20% area. Specifically, our assumptions for 
Sally include the following: 
     -- High-single-digit positive revenue increases and mid- to 
high-single-digit same-store growth;
     -- Modest improvement in margin because of sales leverage, low-cost 
sourcing, and increased sales of higher margin exclusive-label products;
     -- Capital expenditures of about $70 million in fiscal 2012 and about $75 
million in fiscal 2013; and
     -- Share repurchases of $200 million in fiscal 2012 and fiscal 2013.

Liquidity
We believe Sally's liquidity is "strong" and will meet its needs over the next 
12 months. Furthermore, we estimate that there should be no significant 
shortfalls in liquidity in the next two years, given that the company has very 
modest debt maturities until fiscal 2016. 

Our view of the company's liquidity profile incorporates the following 
expectations:
     -- We expect that liquidity sources (including cash, cash flow from 
operations, and availability under its revolving credit facility) will exceed 
uses by 1.5x or more.
     -- We estimate that, when measured over the next 24 months, sources over 
uses will remain well above 1x.
     -- We estimate that liquidity sources will continue to exceed uses, even 
if EBITDA were to decline by 30% and debt is more than 25% below covenant 
limits.
     -- We believe that the company will maintain sufficient availability 
under its revolving credit facility so that no material financial ratio 
maintenance covenant will apply.
     -- We believe that the company has a generally high standing in the 
credit markets.
     -- We expect the company to be able to absorb, without refinancing, 
high-impact, low-probability events.
     -- We believe that the company has well-established, solid relationships 
with banks.

Sally had $54 million of cash and $325.4 million of availability (subject to 
the borrowing base and letters of credit outstanding) under its $400 million 
senior secured asset-based revolving credit facility as of June 30, 2012. We 
expect the company to maintain significant availability over the next year, 
even with estimated peak usage of approximately $100 million. The credit 
facility matures in November 2015. We expect cash flow from operations, 
availability under the revolving credit facility, and cash balances to be 
sufficient for working capital needs, bolt-on acquisitions, and moderate share 
repurchases over the next year.

The unrated revolving credit facility requires Sally to maintain a 
fixed-charge coverage ratio of at least 1:1 if availability under the credit 
agreement falls below the lesser of 15% of the borrowing base and $40 million. 
We estimate that Sally will be able to maintain significant availability under 
the revolving credit facility over the next year; compliance should not be an 
issue, in our view.

Recovery analysis
For the complete recovery analysis, see Standard & Poor's recovery report on 
Sally Holdings LLC, to be published as soon as possible after this report, on 
RatingsDirect.

Outlook
Our rating outlook on Sally is positive. We expect the company to maintain its 
upward momentum, with positive sales and same-store sales, and modest margin 
improvement, which should result in stronger credit protection measures over 
the next year. We could raise the rating if the company were to improve and 
sustain debt leverage (adjusted for operating leases) in the 2.5x area. We 
estimate that this could occur over the next 12 months if Sally's operating 
performance continues at its current pace, with gross margin improving by more 
than 50 basis points (bps) or more while growing revenues in the high-single 
to low-double digit range, or some combination of the two factors.

We could revise the outlook to stable if the company's credit metrics do not 
improve over the next year as we expect, with adjusted debt leverage remaining 
above the 3x area. We estimate that this could occur if sales decline to the 
mid-to low-single digits or operating margins decrease by about 50 bps or more 
or some combination of the two factors. In addition, if the company's 
financial policies become somewhat more aggressive, resulting in debt leverage 
remaining above 3x.

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 
     -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009
     -- Key Credit Factors: Business And Financial Risks In The Retail 
Industry, Sept. 18, 2008 
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008

Ratings List
Ratings Affirmed

Sally Beauty Holdings Inc.
Sally Holdings LLC
 Corporate Credit Rating                BB+/Positive/--    

Sally Capital Inc.
Sally Holdings LLC
 $850 mil. Sr Unsecd notes due 2022     BB+                
   Recovery Rating                      3                  
 $750 mil. Sr Unsecd notes due 2019     BB+                
   Recovery Rating                      3
Comments (0)
This discussion is now closed. We welcome comments on our articles for a limited period after their publication.