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TEXT-S&P removes Rona from credit watch, affirms at 'BBB-'
Overview -- We are affirming our ratings on RONA Inc., including our 'BBB-' long-term corporate credit rating on the company, and removing all ratings from CreditWatch where they were placed with positive implications July 31, 2012. -- We base the affirmation and removal from CreditWatch on U.S. home retailer Lowe's Cos. Inc.'s (A-/Negative/A-2) decision to drop its nonbinding proposal to acquire the company. -- We believe that the various strategic options Lowe's and RONA are considering underscore the saturation in the Canadian home-improvement retail sector--at least for big-box format stores. -- The negative outlook stems from our view that weak market conditions will make it difficult for RONA to maintain leverage below our key 3x threshold in the near term. Rating Action On Sept. 19, 2012, Standard & Poor's Ratings Services affirmed its ratings on RONA Inc., including its 'BBB-' long-term corporate credit rating on the company, and removed all ratings from CreditWatch where they were placed with positive implications July 31, 2012. The outlook is negative. We base the affirmation and removal from CreditWatch on U.S. home retailer Lowe's Cos. Inc.'s decision to drop its nonbinding proposal to acquire the company. Rationale The ratings on RONA reflect Standard & Poor's view of the company's good market position established through a versatile multi-format operating model with strong distribution capabilities and solid market coverage, resilient cash flow in challenging market conditions, and management's commitment to an intermediate capital structure. These factors are partially offset, in our opinion, by intense competition that exacerbates economic cycles during a period of weak demand for home improvement products. We believe that the various strategic options Lowe's and RONA are considering underscore the saturation in the Canadian home-improvement retail sector--at least for big-box format stores. Lowe's has slowed its pace of growth in Canada in recent years because of weak market conditions, while RONA expects to convert up to one-quarter of its big-box stores to smaller formats, likely reducing its retail square footage about 5% through 2013 to better match the sector's reduced demand. A retailer and distributor of hardware, home improvement, and gardening products, RONA had 2011 revenues of about C$4.8 billion. The company operates several banners, the most prominent of which include RONA, Reno-Depot, Totem, and Noble. RONA has been gradually gaining market share through a period of weak demand by expanding its retail and affiliated store network and by broadening its private-label and controlled-brand programs. The company's share of the Canadian hardgoods retailing market is about 19%, which we estimate results in a similar revenue base as that of Home Depot Inc. (A-/Stable/A-2) in Canada and about half of Canadian Tire Corp. Ltd.'s (BBB+/Stable/--) retail segment. Lowe's, now with 25 stores in Ontario and six in western Canada, poses a competitive threat to RONA by adding square footage as RONA contracts, although this is somewhat muted by Lowe's focusing its expansion away from RONA's core market in Quebec. We believe the flexibility of RONA's platform will be tested in 2012 and 2013, as the company converts some of its big-box stores to smaller formats. We expect that this could yield some near-term operational disruptions while retail square footage drops about 5% through 2013, but lower costs--particularly lower fixed costs--should better match the sector's reduced demand. RONA operates a multi-format model that enables it to achieve close to 100% market coverage in Canada, and provides flexible platforms for changing competitive conditions. This strategy, however, constrains operating efficiencies and leads to lower margins than those of its single-format competitors, although RONA's lower margins are typically more stable because of its higher proportion of distribution revenue. The company's share of the building products retail segment is similar to Home Depot's in Canada, but we believe that the company's various formats strengthen its business risk profile by diversifying its competitive pressures. As such, we believe that RONA's extensive distribution network is an important factor supporting its operational strategy, as the company sells to more diffuse regions and market segments than its competitors. Prospects for RONA's operating performance are unsteady, with soft demand amid cautious consumer spending. Notwithstanding aggressive cost cutting in the past few years, revenue stagnation and same-store sales declines have resulted in a sharp reduction in profitability. Same-store sales declined more than 7% in 2011, along with the confluence of strong comparable-store performance in early 2010, poor weather, and shaky consumer confidence. Consequently, RONA's last 12 month (LTM) reported EBITDA margin for the important second quarter has declined significantly on a year-over-year basis to 4.8% (5.7% excluding restructuring charges), from 5.5% a year earlier and 7.4% two years ago. Notwithstanding the pressure on its profitability, RONA has demonstrated its commitment to its intermediate capital structure several times through this recent difficult period, issuing equity in 2009 to reduce debt and repurchasing notes in late 2011 that almost halved the company's reported debt, although the C$172.5 million issuance of preferred shares in early 2011--50% of which is included in our adjusted debt--somewhat offsets the benefits of reduced reported debt. We view the company's LTM leverage of 3.4x as high for the investment-grade rating, and RONA's financial risk profile is exposed to continued weak earnings and seasonality that could keep leverage at 3.0x-3.5x through most of 2012. Moreover, weaker EBITDA has increased LTM reported debt to EBITDA to 2.0x from 1.7x a year ago, while capitalized operating leases and hybrid securities account for the incremental 1.4 turns of our fully adjusted leverage. Liquidity We view the company's liquidity as strong, based on the following expectations: -- Available liquidity (including about C$650 million available under its C$950 million revolving credit facility due in 2016) should comfortably exceed uses by 1.5x through 2013; -- Liquidity sources will continue to exceed uses, even if EBITDA were to decline by 30% in 2012; -- Working-capital swings could consume C$100 million-C$150 million in the seasonally weak first quarter as it builds inventory for spring; -- RONA should generate sufficient cash from operations to cover its lower capital expenditures and its small dividend, contributing to modest free operating cash flow in 2012; and -- There are no meaningful debt maturities until 2016 and we believe that RONA comfortably met the financial covenants under its committed credit facility at June 24, 2012. Outlook The negative outlook stems from our view that weak market conditions will make it difficult for RONA to maintain leverage below our key 3x threshold in the near term. Recent debt reduction provides a significant buffer for our investment-grade rating on RONA in this period of weak earnings, but we could lower the rating if profitability weakens enough to increase leverage to about 3.5x through the critical second and third quarters of 2013 with poor prospects for improvement. Lower debt and significant cost reductions have preserved the investment-grade rating to this point, although we believe management's options to undertake such credit-enhancing measures are more limited in the near term, increasing the company's reliance on improving market conditions to preserve its credit quality. A higher rating is unlikely in the medium term, given the sector's persistently heavy competition, but we could revise the outlook to stable if stronger earnings improve RONA's leverage sustainably to 2.5x-3.0x. Related Criteria And Research -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008 -- Key Credit Factors: Business And Financial Risks In The Retail Industry, Sept. 18, 2008 Ratings List RONA Inc. Ratings Affirmed And Removed From CreditWatch To From Corporate credit rating BBB-/Negative/-- BBB-/Watch Pos/-- Senior unsecured debt BBB- BBB-/Watch Pos Preferred stock Global BB BB/Watch Pos Canada P-3 P-3/Watch Pos 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.
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