TEXT-S&P raises Rent-A-Center to 'BB+'

Thu Oct 11, 2012 2:54pm EDT

Overview
     -- North American rent-to-own retailer Rent-A-Center has demonstrated the 
willingness and ability to maintain credit ratios within levels indicative of 
an "intermediate" financial risk profile.
     -- We are raising the corporate credit rating to 'BB+' following our 
upward revision of the company's financial risk profile to intermediate from 
"significant."
     -- The stable outlook reflects our expectation for the company to 
maintain credit ratios indicative of an intermediate financial risk profile 
and for the company's business risk profile to remain "fair" for at least the 
next two years.


Rating Action
On Oct. 11, 2012, Standard & Poor's Ratings Services raised its corporate 
credit rating on Plano, Texas-based rent-to-own retailer Rent-A-Center Inc. to 
'BB+' from 'BB'. The outlook is stable.

At the same time, we raised our issue-level rating on the company's $300 
million 6.625% senior notes to 'BB' (one notch below the corporate credit 
rating) from 'BB-'. The recovery rating remains '5', indicating our 
expectation of modest (10% to 30%) recovery for noteholders in the event of a 
payment default or bankruptcy. 


Rationale
The rating action reflects Standard & Poor's expectation that the company has 
both the willingness and ability to maintain credit ratios indicative of an 
intermediate financial risk profile. We continue to view the company's 
business risk profile as fair.

The ratings on Rent-A-Center reflect Standard & Poor's analysis that the 
company's business risk profile will remain fair for at least the next two 
years, based on the company's meaningful presence in the U.S., ongoing 
geographic expansion in Mexico, and recent channel expansion with RAC 
Acceptance. We believe the company continues to lack a meaningful 
international presence and it remains vulnerable to potentially increasing 
consumer finance protection regulations in the U.S.  We have revised the 
company's financial risk profile upward to intermediate from significant, 
principally because we forecast the company can sustain credit ratios within 
the range indicative of an intermediate financial risk profile. A key aspect 
of our forecast includes the assumption that financial policies will remain 
moderate, meaning dividends, share repurchases, and potential acquisitions 
will be funded with internally generated cash flows.

Our forecast for key credit ratios through the end of 2013 is as follows:
     -- Lease-adjusted debt to EBITDA reaching 2.7x by the end of 2012 and 
2.6x by the end of 2013. As of June 30, 2012, we calculate leverage was 2.8x.
     -- Funds from operations (FFO) to total debt reaching 39% by the end of 
2012 and 41% by the end of 2013. As of June 30, 2012, we calculate FFO to 
total debt was 37%.
     -- Debt to capital remaining at 46% at the end of 2012 and reaching 44% 
by the end of 2013. As of June 30, 2012, we calculate adjusted debt to capital 
was 46%.

Financial ratios indicative of an intermediate financial risk profile include 
leverage between 2x and 3x, FFO to total debt between 30% and 45%, and debt to 
capital between 35% and 45%.

Standard & Poor's economists believe the risk of another U.S. recession during 
the next 12 months is between 20% and 25%. We expect GDP growth of just 2.2% 
this year and only 1.8% in 2013, consumer spending growth of between 2.0% and 
2.3% per year through 2013, and the unemployment rate remaining at or above 8% 
through late 2013 (see "U.S. Economic Forecast: He's Buying A Stairway To 
Heaven," published Sept. 21, 2012, on RatingsDirect). Considering these 
economic forecast items, our base-case forecast for the company's operating 
performance over the next two years is as follows:
     -- Revenue growth in the high-single digit percent area, supported by RAC 
Acceptance kiosk growth and international expansion in Mexico and, to a lesser 
extent, Canada.
     -- Gross margin (excluding depreciation and amortization) declines by 
about 50 basis points (bps) to about 17.5%, as the company further grows its 
lower-margin RAC Acceptance business and new stores in Mexico take time to 
reach their full potential. 
     -- Selling, general, and administrative (SG&A) expense growth no longer 
outpaces revenue growth. This trend began in early 2012 and we expect it to 
continue, largely because the RAC Acceptance business requires less SG&A.
     -- EBITDA margin declines versus the prior year and settles between 14% 
and 15%.
     -- Debt reduction is limited to the contractual amortization of $25 
million per year under the term loan.

We view the company's financial risk policies as moderate. Significant debt 
reduction has occurred since 2006, though the rate of decline has slowed since 
2009 and we believe accelerated debt reduction is unlikely to resume for the 
foreseeable future. The company instituted a regular cash dividend during the 
third quarter of 2010; we forecast cash dividends of about $40 million per 
year. We believe the company will fund dividends, share repurchases, and 
potential acquisitions with discretionary cash flows.

The company's primary focus on rent-to-own transactions is a key ratings risk 
factor, especially with nearly all of its stores in the U.S. and the potential 
for U.S. regulation to hurt the rent-to-own retail business model. Current 
U.S. regulation focuses on strengthening consumer finance protection 
regulations. Increased consumer finance protection regulations on rental 
purchase transactions could require the company to alter its business 
practices in a manner that impairs performance. For example, regulatory 
changes could involve areas such as customer disclosure, rental terms, grace 
periods, and pricing caps. At this time, it is difficult to quantify the 
potential negative impact, though the lingering issue will constrain the 
business risk profile for the foreseeable future.

We believe the company's RAC Acceptance business and international expansion 
will be key growth drivers. Management estimates the company's RAC Acceptance 
kiosks will increase to 950 by the end of 2012. As of June 30, 2012, there 
were 811 RAC Acceptance kiosks in service, up from 750 at the beginning of the 
year. International expansion is likely to accelerate, in part because growth 
prospects in the U.S. rent-to-own industry are becoming more limited as the 
industry matures. The company is focusing on Mexico--with 67 stores open as of 
June 30, 2012--and, to a lesser extent Canada, with 32 stores open as of June 
30, 2012. Establishing a meaningful presence outside the U.S. could be one 
catalyst for a higher business risk profile, because it would reduce the 
company's vulnerability to changes in U.S. regulations and it would increase 
the company's long-term growth prospects. We believe it will take considerable 
time for the company to build a meaningful presence outside the U.S., given 
the rent-to-own industry's limited existence in most international markets.


Liquidity
We view the company's liquidity as "adequate." We expect the company's cash 
sources to exceed its cash uses over the next 24 months. Our assessment of the 
company's liquidity profile includes the following expectations, assumptions, 
and factors:
     -- We forecast cash sources will exceed cash uses by more than 1.2x over 
the next 12 months and will remain positive over the next 24 months.
     -- We forecast net sources would remain positive, even if EBITDA were to 
decline 15%.
     -- We forecast covenant cushion should remain sufficient.
     -- Contractual debt amortization is manageable, at $25 million per year.
     -- Debt maturities are favorable, with the revolving credit facility and 
term loan due in 2016 and the senior notes due in 2020.

As of June 30, 2012, we calculate total liquidity was about $360 million, 
which included revolver availability of about $260 million. Over the past 
eight quarters, average revolver availability was near $237 million, and 
fluctuated between $180 million and $280 million during this time. We expect 
this pattern to continue.

We forecast free cash flow of about $100 million in 2012 and about $130 
million in 2013, which incorporates our expectation for capital expenditures 
to remain near $100 million per year. We assume share repurchases, dividends, 
and potential acquisitions consume the majority of discretionary cash flow.


Recovery analysis
For the complete recovery analysis, please see the recovery report on 
Rent-A-Center Inc., to be published on RatingsDirect following this report.

Outlook
The outlook is stable, reflecting our expectation for the company to maintain 
credit ratios indicative of an intermediate financial risk profile and for the 
company's business risk profile to remain fair for at least the next two years.

We could lower our ratings if the company is unable, through weaker operating 
performance, or unwilling, through debt-financed share repurchases or 
dividends, to maintain credit ratios indicative of an intermediate financial 
risk profile, which includes leverage sustained below 3x. Based on 
second-quarter financial results, an EBITDA decline of between 7% and 7.5% or 
a debt increase of nearly $100 million would cause leverage to increase to 
3.0x.

It is unlikely we will raise our ratings within the next two years, because we 
believe the company's business risk profile will remain fair for that time. 
The company's ability to replicate the success of its U.S.-based business 
model in other countries would improve its geographic diversity, which could 
be a catalyst for a higher business risk profile. We believe it will take a 
considerable amount of time for the company to build similar scale in an 
international market.


Related Criteria And Research
     -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
     -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
     -- 2008 Corporate Ratings Criteria: Ratios And Adjustments, April 15, 
2008 

Ratings List
Ratings Raised; Recovery Rating Unchanged
                                        To                 From
Rent-A-Center Inc.
 Corporate Credit Rating                BB+/Stable/--      BB/Stable/--
 Senior Unsecured                       BB                 BB-
   Recovery Rating                      5                  5
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