S&P rates Savers' term loan c 'b' (recovery rating: 3)
Sept 25 (Reuters) - (The following statement was released by the rating agency) Overview -- Bellevue, Wash.-based thrift store operator Savers Inc. is issuing a new $715 million term loan C to refinance its existing term loan B, repay revolver borrowings, and fund the purchase of a small regional thrift store chain. -- We are assigning a 'B' issue-level rating and '3' recovery rating to the proposed term loan C due 2019. -- We are affirming Savers' corporate credit rating at 'B', given this transaction. -- The stable outlook reflects our belief that despite moderate operational improvement, credit protection metrics will remain in line with our financial risk assessment over the coming year. Rating Action On Sept. 25, 2012, Standard & Poor's Ratings Services affirmed its corporate credit rating on Savers Inc. at 'B'. The outlook is stable. At the same time, we assigned a 'B' issue-level rating with a '3' recovery rating to the new term loan C. The '3' recovery rating indicates our expectation for meaningful (50% to 70%) recovery of principal in the event of a payment default. Savers expects to use the proceeds from the new $715 million term loan C to refinance its existing term loan B, fund the acquisition of a small regional thrift chain and repay revolver borrowings. Upon the closing of the new term loan C, we expect to withdraw the rating on the existing term loan B. Rationale The rating on for-profit thrift retailer Savers reflects Standard & Poor's expectation that despite moderate operational gains, the company's financial risk profile will remain "highly leveraged" in the coming year. The regional thrift chain acquisition is small, adding less than 5% to Savers' EBITDA. However, the deal allows Savers to grow in the Midwestern U.S. and reduce costs through modest synergies. The acquisition is leverage-neutral, with pro forma debt to EBITDA remaining at 7.9x in the year ended June 30, 2012, which is the same as following the private equity sale to buyers including Leonard Green & Partners L.P. and TPG earlier this year. Leverage remains flat because added operating earnings from the target offsets moderately higher debt. Meanwhile, interest coverage will improve slightly to 2.6x from 2.5x for the transaction as the term loan and revolver re-pricing affords the company about $5 million in interest savings. Savers continues to post strong performance, with sales up 21% and EBITDA up 23% in the year through June 30, 2012 because of recent positive comparable-store sales in both the U.S. and Canada. Our outlook for the thrift industry remains positive in the coming year, as customers remain frugal in the still-weak economy and merchandise reuse and recycling garner growing acceptance. However, we view Savers' business risk profile as "weak," reflecting its narrow focus and potential for merchandise shortages if charitable donations decline. Other risks include increased competition from mass merchants and exposure to foreign currency exchange rates. We expect an estimated 26% EBITDA increase for the fiscal year ending Dec. 31, 2012, as Savers continues to grow its comparable-store sales and integrate the new small regional thrift stores. We project this operational enhancement will push leverage down to the low-7.0x area by the end of fiscal 2012 and to the high-5.0x area by the end of fiscal 2013 as the company benefits from continued high repeat traffic and improved operating leverage. We expect Savers' EBITDA margin to increase 190 basis points (bps) to 17.7% in fiscal 2012 because of benefits from the small regional thrift chain acquisition and as Savers continues to integrate highly efficient Apogee stores acquired last year. Standard & Poor's economists currently forecast a 20% likelihood of a U.S. recession, with GDP rising 2.1% in 2012 and 2.4% in 2013, unemployment remaining at or near 8%, and consumer spending rising 2.2% in 2012 and 2.1% in 2013. Considering these economic assumptions, our forecast for Savers' operating performance for fiscal 2012 includes the following: -- We expect overall sales to increase 12% as the company opens between 20 and 25 new stores and comparable-store sales remain in the high-single-digit percentage area. -- We believe gross margin will increase 20 to 30 bps, reflecting an increase in higher-margin On-Site Donations. -- We anticipate total selling, general & administrative (SG&A) expenses will increase in the 10% area because of store growth. -- We expect funds from operations (FFO) to debt will remain in the mid- to low-teens because of continued earnings expansion. We project Savers will generate $20 million to $25 million in free cash flow in fiscal 2012, similar to recent years. We believe debt reduction will be modest, given expectations for increased capital spending to support new store openings and other initiatives. Although the company uses various hedging techniques to partly mitigate exchange rate volatility between the Canadian dollar and U.S. dollar, some risk exists, given all of company's debt is denominated in U.S. dollars, while a large amount of cash flow is generated in Canadian dollars. Liquidity Savers has adequate sources of liquidity. Relevant aspects of the company's liquidity, in our view, are as follows: -- We expect coverage of sources over uses over the next 12 to 18 months to be above 1.2x. -- We expect net sources would be positive, even with a 15% drop in EBITDA. -- No debt maturities over the coming year. -- There are no covenants on the new term loan ("covenant lite") and no financial maintenance covenants on the revolver unless borrowings exceed $15 million. -- The company appears to have good relationships with its banks, based on its track record. Sources of liquidity mainly consist of $17 million of pro forma cash on the balance sheet, the revolver, and funds from operations. Uses include term loan amortization and capital expenditures. We expect the company's expansion plans to require capital expenditure of approximately $50 million to $60 million per year (including maintenance spending). We expect continued minimal use of the revolver in the coming year. Recovery analysis For the complete recovery analysis, see the recovery report on Savers, to be published on RatingsDirect as soon as possible following the release of this report. Outlook The rating outlook is stable. We believe Savers will continue to perform well over the coming year as still-high unemployment and a weak U.S. housing market spurs demand for used goods. We would consider lowering our rating if U.S. and Canadian economic slowdowns leads to lower-than-expected charitable donations and subsequent merchandising supply shortages. This would lead to slower revenue growth and margin contraction such that leverage remains in the 7.0x area. In our view, that could occur if sales increase in the single-digit percentage area or gross margin falls 50 basis points in fiscal 2012. This would result in EBITDA increasing only in the single-digit percentage range from current pro forma levels. We could also lower ratings if the company's new owners add significant additional debt in the coming year to fund a dividend or large acquisition in the intermediate term. Given Savers' credit measures, U.S. expansion plans and acquisitive nature, we are not expecting to raise our ratings over the coming year.
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