TEXT-S&P cuts Roundy's Supermarkets rating to 'B'
Overview -- U.S. grocery store operator Roundy's Supermarkets' operating performance was weaker than expected in the second quarter as a result of weak economic conditions and intensifying industry competition. We believe that trend will continue, at least for the near term. -- We are lowering our ratings on Roundy's one notch, including the corporate credit rating to 'B' from 'B+'. -- The stable outlook reflects that, while we expect profit declines and weaker credit ratios over the next year, those ratios are likely to remain appropriate for the current rating category. Rating Action On Sept. 7, 2012, Standard & Poor's Ratings Services lowered its ratings on Milwaukee-based Roundy's Supermarkets Inc., including the corporate credit rating to 'B' from 'B+'. The outlook is stable. The downgrade comes after weaker-than-expected operating trends in the second quarter as a result of increased price competition and effective marketing programs from competitors. We expect these factors will lead to weaker performance and further credit metric deterioration. Rationale The rating on Roundy's reflects our view of the company's business risk profile as "weak," which we revised from "fair." This change incorporates that weak economic conditions and new entrants into the industry, particularly discounters, will increase competition and weaken the company's operating performance and market presence. This is somewhat offset by the company's relatively good presence in its local markets. We view Roundy's financial risk profile as "highly leveraged," based on forecasted credit ratios. Roundy's second-quarter operating trends, highlighted by a same-store sales decline of 3.3% and an EBITDA deterioration of about 7.6%, were below our expectations and weaker than most industry peers. For the remainder of 2012, we anticipate further profit declines as the company takes price investments as a result of competitors more aggressive pricing strategies and marketing campaigns-leading to lower sales and operating margins. Below are our more specific operating assumptions for 2012: -- Sales growth of about 1%--new stores will offset a comparable-store decline of about 2.5%-3.5% for the year; -- We anticipate slight gross margin contraction of 10-20 basis points (bps); -- Growth of general and administrative costs of about 3.0%-3.5%; with expected sales growth, this would lead to EBITDA margin contraction of about 50 bps; and -- EBITDA between $205 million and $210 million. With our performance expectations, we project credit ratios, adjusted for operating leases and company-sponsored pension plans at the end of 2012, to be as follows: -- Debt to EBITDA in the 5.8x-6.0x range; -- Adjusted EBITDA coverage of interest of 2.2x-2.3x; and -- Funds from operations (FFO) to debt near 10%. These ratios are in line with indicative ratios of highly leveraged financial risk profiles. Historically, Roundy's operating trends have been consistent as compared to many industry peers, and the company has been less vulnerable to weak economic conditions and industry competition. The recent performance indicates that Roundy's will be vulnerable to these factors over the near term. However, the company still has a relatively good presence in many of its markets, and we expect that performance could stabilize in 2013 if the company's pricing strategies are more effective and industry competition moderates. Liquidity We view Roundy's liquidity as "adequate," which indicates our expectation that liquidity sources should be greater than uses by a ratio of 1.2 to 1.0 over the next two years. As of June 30, 2012, Roundy's sources of liquidity include available borrowings of $94.9 million on its revolving credit facility, excess cash which we estimate to be about $50 million-$60 million, and forecasted FFO of about $130 million. We foresee liquidity uses to include some working capital needs, capital spending between $60 million and $70 million, cash dividends between $35 million and $40 million, term loan amortization annually of $6.75 million, and cash flow sweep payments. Given the dividend payments and capital spending assumptions, we expect Roundy's to generate about $25 million to $30 million of discretionary cash flow. Relevant aspects of Roundy's liquidity are as follows: -- We see coverage of uses by sources to be in excess of 1.2x for the next two years; -- We expect that sources would exceed uses even with a 15% drop in EBITDA; -- We anticipate that the company will maintain adequate headroom over maintenance financial covenants; -- The company has sound relationships with its banks and a satisfactory standing in the credit markets, in our view; and -- Manageable near-term amortizations. Recovery analysis For the complete recovery analysis, please see the recovery report on Roundy's, published Feb. 2, 2012, on RatingsDirect. Outlook The outlook is stable. This incorporates expected profit declines and credit metric deterioration, but we believe credit ratios will remain appropriate for the financial risk assessment and rating category. We also expect Roundy's to maintain adequate liquidity and generate positive discretionary cash flow. If the operating declines are meaningfully worse than expected and EBITDA was near $180 million, leading to leverage in the high-6x area and EBITDA coverage of interest below 2x, we would likely consider a lower rating. This could occur in 2012 if total revenue increased 1%, gross margins contracted 50 bps, and operating and administrative expenses increased about 3.2%. Conversely, given the company's operating trajectory and industry conditions, we do not expect to consider a higher rating in the near term. However, if it could improve leverage to the low-5x area and coverage to the mid-2x area, we may consider a positive rating action. For that to occur, EBITDA would need to improve to about $235 million, which we do not view as likely in the near term. 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 Downgraded To From Roundy's Supermarkets Inc. Corporate Credit Rating B/Stable/-- B+/Stable/-- Senior Secured B+ BB- Recovery Rating 2 2
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