TEXT-S&P raises Vitamin Shoppe to 'BB'
Overview -- U.S. specialty retailer Vitamin Shoppe has improved its credit metrics and sustained operational gains over the past year as its growth has outpaced the industry average. -- We are raising our corporate credit rating on the company to 'BB' from 'BB-'. -- The stable outlook reflects our expectation that the company will maintain its positive momentum of sales and profitability and that its financial policies will remain moderate, resulting in stable to modestly improving credit metrics over the next year. Rating Action On Sept. 26, 2012, Standard & Poor's Ratings Services raised its corporate credit rating on North Bergen, N.J.-based Vitamin Shoppe Industries Inc. to 'BB' from 'BB-'. The outlook is stable. Rationale The rating on Vitamin Shoppe reflects our assessment that the company's financial risk profile is "significant" and the business risk profile is "fair." The financial risk profile reflects Vitamin Shoppe's moderate financial policies, no funded debt, and its good cash flow generation. We view the business risk profile as fair, reflecting Vitamin Shoppe's position as the No.2 player in the highly competitive and fragmented retail vitamin industry, the company's deep product offerings compared to its competitors, our expectation of growth greater than the industry average, and the risks associated with its store expansion plans. Credit measures have strengthened over the past year because of EBITDA growth and repayment of all funded debt. As a result, leverage improved to 2.6x for the 12 months ended June 30, 2012, from 2.8x a year ago, and interest coverage strengthened to 4.9x from 3.8x year over year. We expect total debt (which is only capitalized operating leases) to EBITDA to remain in the mid- to high-2x range in fiscal 2012, as continued growth in lease commitments will likely partially offset EBITDA growth. Although credit metrics may be indicative of a higher financial risk score, the absolute size of its cash flow is a limiting factor. Specifically, our assumptions for Vitamin Shoppe over the next year include the following: -- Revenue growth in the low-double-digit area, with same-store sales of more than 5%; -- Gross margin improvement of about 50 basis points (bps); -- Adjusted EBITDA margin in the mid-to-high teens, benefiting from continued leveraging of its economies of scale; and -- Capital expenditures in the $40 million to $45 million range. We expect sales trends to remain positive as the company continues to grow faster than the industry because of its broad product offerings and market position. We attribute the improved performance to growth in a more fitness-conscious market, customers' increasing need for condition-specific products, and improved marketing efforts. In addition, comparable-store sales are benefiting from the maturation of Vitamin Shoppe's younger store base. We estimate that adjusted EBITDA margin improved by about 120 bps for the 12 months ended June 30, 2012, to 16.7% from 15.5% in the prior year. In addition, the company's maturation cycle of newly opened stores, moderate promotional activity, and expectations for modest inflation in the near term should help manage cost pressures from raw materials and higher expenses to support the pace of its new store growth strategy. Liquidity We believe Vitamin Shoppe's liquidity is "adequate." We estimate that the company's liquidity is sufficient to meet its needs over the next 12 months. Our view of the company's liquidity profile incorporates the following: -- We expect liquidity sources (including cash and availability under its $70 million revolving credit facility) to exceed uses by 1.2x or more. -- We estimate that liquidity sources will continue to exceed uses, even if EBITDA declines by 15%. -- We believe that the company will maintain adequate availability under its revolving credit facility and do not expect any covenant compliance issues because covenants do not apply unless availability falls below 10%. -- We believe Vitamin Shoppe has a satisfactory standing in the credit markets. -- Also, we believe that the company has generally prudent risk management, given that the only debt it has is capitalized operating leases. As of June 30, 2012, sources of liquidity included about $50 million of cash and about $69 million of availability under the $70 million revolving credit facility, maturing on Sept. 25, 2015. There are no financial covenants unless the revolving credit facility's availability falls below 10%, which we do not expect to occur in the near term. We expect that the company will continue financing its store expansion with internally generated cash flow, and we expect operating cash flow to remain the primary source for capital expenditures, investment in infrastructure, and growth into Canada in fiscal 2012. By fiscal year-end, we expect free operating cash flow of about $64 million. Outlook Our outlook on Vitamin Shoppe is stable. We expect the company to modestly improve current credit metrics and margins due to sales leverage and growth in profitability, despite expectations for about 48 new stores in fiscal 2012. We expect adjusted leverage to remain in the mid-2x area, adjusted funds from operations to total debt in the mid-30% area, and EBITDA to interest in the 5x area. We would consider a downgrade if credit metrics deteriorate because of debt-funded shareholder-friendly initiatives, leading to adjusted debt leverage approaching the 3.5x area. Also, we estimate leverage could increase if operating performance declines due to adverse regulatory measures, negative publicity, or competitive pressures such that EBITDA declines by 30%. This could occur, for example, if revenue growth slows to the low-single digits, gross margins contract by 100 bps or more, or some combination of the two. We could consider an upgrade if credit ratios demonstrate further improvement because of consistently strong same-store sales and EBITDA growth that outpaces increases in lease commitments. If positive operating performance enhances credit metrics such that leverage improves to below 2x and the company sustains this metric for several quarters, we could consider an upgrade. For this to occur, sales growth would have to be in the mid-to-high teens, and margins would have to expand by 200 bps or more or some combination of the two. Related Criteria And Research -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Key Credit Factors: Business And Financial Risks In The Retail Industry, Sept.19, 2008 -- 2008 Corporate Criteria: Our Rating Process, April 15, 2008 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Upgraded To From Vitamin Shoppe Industries Inc. Corporate Credit Rating BB/Stable/-- BB-/Stable/-- 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.