TEXT-S&P affirms Collective Brands B rating
Overview -- Blum Capital, Golden Gate Capital, and Wolverine World Wide Inc. are acquiring global footwear retailer Collective Brands in a $2 billion transaction. -- Concurrently, Collective Brands is issuing a $275 million term loan and $250 million asset-based revolver to fund the transaction. -- We are affirming the 'B' corporate credit rating on Collective Brands and removing the rating from CreditWatch with negative implications, while assigning a 'B' issue-level rating with a '4' recovery rating to the term loan. -- The stable outlook reflects our belief that despite modest operational improvement, credit protection metrics will remain in line with our financial risk assessment over the intermediate term. Rating Action On Sept. 7, 2012, Standard & Poor's Ratings Services affirmed its 'B' corporate credit rating on Topeka, Kan.-based Collective Brands Inc. At the same time, we removed the rating from CreditWatch with negative implications, where it was placed on May 3, 2012. The outlook is stable. We also assigned a 'B' issue-level rating with a '4' recovery rating to the new term loan. The '4' recovery rating indicates our expectation for average (30% to 50%) recovery of principal in the event of a payment default. Blum and Golden Gate are funding the transaction with financial sponsor common equity, the term loan, and the unrated revolver. This new revolver will replace the company's existing $300 million unrated revolving loan facility. The company is using the proceeds from the financing mainly to purchase $600 million in public stock. We expect Collective will repay its existing $480 million in senior secured term loan and $126 million in senior subordinated notes after the completion of the transaction by the end of 2012, at which time we will withdraw our ratings on both pieces of debt. Rationale The rating on global footwear retailer Collective reflects Standard & Poor's expectation that the company's financial risk profile will remain "highly leveraged" and its business risk profile will remain "vulnerable" this year despite efforts to improve merchandising and pricing and continue closing certain unprofitable Payless ShoeSource stores. Collective is increasing total debt to EBITDA from 4.8x in the year ended July 28, 2012, to 5.7x pro forma for the deal, reflecting the Golden Gate and Blum acquisition. Pro forma debt includes the $275 million term loan, $75 million of drawn revolver, and other debt mainly related to pensions and leases. We expect interest coverage to decline to an estimated 2.1x from 2.9x before the transaction. We also expect credit metrics to improve slightly by year-end due to stronger back-to-school and holiday sales compared to 2011. Our outlook for the footwear sector that includes Collective's main Payless ShoeSource stores remains negative due to oversupply. The outlook is more favorable for the Performance & Lifestyle Group (PLG) Wolverine is acquiring as part of this transaction. That unit includes wholesale brands Saucony, Keds, Stride Rite, and Sperry Top-Sider and has experienced faster growth than Payless in the past year. Collective's "vulnerable" business risk profile reflects Payless' participation in the highly fragmented global footwear industry, which has seen increased competition in recent years from mass market discounters and specialty retailers considered more moderately priced. This trend hurt Collective as it skewed toward more expensive shoes during the recession, when high unemployment reduced disposable income for the company's core demographic. However, Payless has since refocused on its traditional lower price market and is seeing improved results in the first half of 2012. We expect a 3.4% adjusted EBITDA increase for the fiscal year ending Dec. 30, 2012, due to slightly positive comparable-store sales. We project the company's adjusted EBITDA margin will increase 30 basis points (bps) to 8.8% in fiscal 2012 as modest labor cost savings from store closures propel improved operating leverage. We believe future growth will come from expanding Payless stores overseas to cater to the emerging middle class, especially in Latin America, rather than adding stores in the saturated U.S. market. We expect the U.S. store base will continue to shrink in coming years and do not expect new franchised stores. Principal economic factors we considered in our forecast include real GDP growth of 2.1% in 2012 and 1.8% in 2013, consumer spending growth of 2% in 2012 and 2.3% in 2013, and the unemployment rate remaining at or above 8% through 2013. Further specific details underlying our fiscal 2012 forecast for Collective include: -- We expect overall sales will remain flat as positive same-store sales offset continued net store closures. -- We believe gross margin will stay flat as the company liquidates seasonal inventory and reduces promotional selling in favor of consistently low prices. -- We anticipate total selling, general, and administrative (SG&A) expenses will decrease in the low-single-digit percent rate due to a reduced retail base and the sale of PLG. -- We forecast funds from operations (FFO) to total debt will be in the 25% range after the deal from the low-20% range due to slightly lower pro forma debt. Liquidity We view Collective's liquidity as "adequate," as we expect sources of liquidity to be greater than uses over the next 12 to 18 months. Sources of cash include the new revolver, FFO, and modest excess cash following the transaction. Cash uses include debt amortization and reduced capital spending. 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 also forecast net sources would remain positive even if EBITDA were to decline 15%. -- The company consistently maintained sound covenant cushions under its previous credit agreement and will have a springing fixed-charge covenant under the new revolver depending on availability. -- There are no near-term debt maturities. Recovery analysis For the complete recovery analysis, see the recovery report on Collective, to be published soon after this report on RatingsDirect. Outlook The stable outlook reflects our expectation that modest operational improvement, coupled with limited debt reduction, will result in slightly improved credit measures in the coming year. We could lower the rating if comparable-store sales turn negative again due to merchandise or pricing missteps, leading to a weaker-than-expected second half of 2012. This would result in gross margin falling 200 bps and EBITDA declining about 20% from our expectations for fiscal 2012. In this scenario, interest coverage would fall below 2x, leverage would approach 7x, and FFO to total debt would decline below 10%. Given Collective's expected credit measures and strategic realignment, as well as our industry outlook, 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 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- Key Credit Factors: Business And Financial Risks In The Restaurant Industry, Dec. 4, 2008 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Ratings Affirmed And Off CreditWatch To From Collective Brands Inc. Corporate Credit Rating B/Stable/-- B/Watch Neg/-- New Ratings Collective Brands Inc. Senior Secured US$275 mil term loan bank ln due 2019 B Recovery Rating 4 Ratings Affirmed And Off CreditWatch; Recovery Ratings Unchanged To From Collective Brands Inc. Senior Secured B+ B+/Watch Neg Recovery Rating 2 2 Subordinated CCC+ CCC+/Watch Neg Recovery Rating 6 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.