TEXT-S&P rates Reliance Intermediate Holdings 'BB+'
Overview -- We are assigning our 'BB+' long-term corporate credit rating, and stable outlook, to Reliance Intermediate Holdings LP and subsidiary Reliance LP (collectively, Reliance), taking into account the entities' consolidated credit profile. -- We are also raising our issue-level rating on Reliance LP's senior secured notes to 'BBB' from 'BBB-', and assigning our '1' recovery rating to the debt. -- In addition, we are raising our issue-level rating on Reliance Intermediate Holdings LP's senior secured notes to 'BB' from 'BB-', and revising our recovery rating on the debt to '5' from '4'. -- The stable outlook is predicated on a steady consolidated financial risk profile, with debt to EBITDA of about 4.5x and funds from operations to debt of about 15%, as Reliance adds debt slowly to support growth, while distributing substantially all free cash flow to its sole shareholder. Rating Action On Nov. 16, 2012, Standard & Poor's Ratings Services assigned its 'BB+' long-term corporate credit rating to Reliance Intermediate Holdings LP and subsidiary Reliance LP, taking into account the entities' consolidated credit profile. The outlook is stable. At the same time, Standard & Poor's raised its issue-level rating on Reliance LP's senior secured notes to 'BBB' (two notches above the corporate credit rating) from 'BBB-', and assigned its '1' recovery rating to the debt, indicating an expectation of very high (90%-100%) recovery in the event of a default. In addition, we raised our issue-level rating on Reliance Intermediate Holdings LP's senior secured notes to 'BB' (one notch below the corporate credit rating) from 'BB-', and revised our recovery rating on the debt to '5' from '4'. A '5' recovery rating indicates our expectation of modest (10%-30%) recovery if a default occurs. Rationale The ratings on Reliance Intermediate Holdings LP and Reliance LP reflect what Standard & Poor's views as the company's strong business risk profile, characterized by the solid market position and stable cash flows from its water heater rental business, which contributes about three-quarters of the company's 2011 EBITDA. The ratings also reflect the company's aggressive financial risk profile, evidenced by high debt leverage and large distributions to equityholders. We assess Reliance Intermediate Holdings LP's credit profile on a consolidated basis with its subsidiary, Reliance LP. Reliance Intermediate Holdings LP is a pure holding company whose only asset is its equity interest in Reliance LP. The consolidated entity (Reliance) has a large debt load from the June 2007 acquisition of the assets by Alinda Infrastructure Fund I LP, managed by Alinda Capital Partners Ltd., a private investment firm specializing in infrastructure assets. Neither Reliance Intermediate Holdings LP nor Reliance LP releases financial statements publicly. The company's core water heater rental business enjoys favorable demand characteristics supported by the essential nature of water heaters for homes in Ontario, customers' preference for renting rather than owning water heaters, and good affordability due to low rental payments. In our view, these favorable factors are offset by the portfolio's modest attrition owing to aggressive competition from smaller players and weaker housing conditions. We believe that Reliance's faster-growing security and monitoring business increases the company's risk profile somewhat, considering its less attractive market position and lower margins. We believe that Reliance enjoys a strong market position in all its business segments. The company's position in the water heater rental segment is particularly strong and sustainable as high capital intensity, a strong track record, and long-standing relationships with both water heater manufacturers and homebuilders establish high barriers to entry. In our opinion, this has given incumbents the ability to increase rental rates, which are not regulated, to cover inflation and increases in operating costs, while smaller competitors increase the portfolio's attrition rate. The water heater rental segment also enjoys a high EBITDA margin of more than 50% because of low maintenance intensity, low technology risk, and the long operating life of water heater assets. These favorable factors combine to ensure stable and predictable cash flows in this core business segment, which in turn support what we consider the company's strong business risk profile. Standard & Poor's believes that Reliance's security and monitoring business faces more intense competition and higher operating costs. Despite being the second-largest player in Canada, the company operates in a more fragmented industry with smaller and regional players capturing about half of the market. Reliance's customer attrition rate compares favorably with the industry, but it is still higher than that of Reliance's water heater segment and moderately offsets the strength of the water heater rental business. Slower housing starts in Ontario will continue to be a drag on organic unit growth in both water heater rentals and monitoring, exposing the company further to attrition stemming from the aggressive tactics of small competitors. That said, we believe that the company has mitigated the higher operating costs associated with attrition and portfolio defense with its ability to increase rental rates, and to increase its rental business in the heating, ventilation, and air conditioning segment. We believe that Reliance's strong business risk profile supports its aggressive financial risk profile, which is characterized by credit measures that are consistent with the 'B' rating category. We estimate the company's consolidated last 12 months adjusted total debt to EBITDA at about 4.7x and adjusted funds from operations (FFO) to total debt of about 15%, both of which are consistent with 'B' category financial risk parameters. Nevertheless, we expect that such credit measures should enable the company to deploy its operating cash flow to finance its maintenance capital expenditure and to distribute to shareholders. Considering the robust cash flow and good earnings visibility, we believe that the issuer has unusually good control over its financial ratios, demonstrated by its steady increase in debt to fund capital expenditures while making large shareholder distributions and improving leverage modestly in recent years. Reliance has increased debt by C$140 million since mid-2010 to fund growth capital expenditures and acquisitions, while paying out C$170 million in dividends--substantially all of its free operating cash flow for the corresponding period, as expected. Liquidity We view Reliance's liquidity as adequate. Liquidity is normally only a secondary credit factor for Reliance, considering its high margins and predictable capital expenditures. Our view of the company's liquidity profile incorporates the following expectations: -- Liquidity sources (including cash, discretionary cash flow, and availability under its revolving credit facility) will exceed uses by more than 1.2x through 2013; -- Liquidity sources will continue to exceed uses, even if EBITDA were to decline by 30% in 2012 and 2013; -- Scheduled debt maturities are manageable and we expect them to be refinanced in the near term; and -- The company has good relationships with its banks and good standing in credit markets. Recovery analysis For the complete recovery analysis on Reliance see the recovery report to be published on RatingsDirect on the Global Credit Portal following this research update. Outlook Our stable outlook is predicated on our view of a steady consolidated financial risk profile, with debt to EBITDA of about 4.5x and FFO to debt of about 15%, as Reliance adds debt slowly to support growth, while distributing substantially all free cash flow to its sole shareholder. We expect that pressure on the Reliance ratings would emerge if consolidated leverage approached 5x or FFO to debt dropped to about 12%, which could occur if costs for customer acquisition or retention rise amid higher debt for organic growth and acquisitions. In such a scenario, distributions would likely be a key factor in defining credit quality. We believe that the prospects for a higher rating are limited with the current financial risk profile, given that leverage is likely to remain steady as debt rises along with higher earnings. In addition, we believe the current financing structure that compels distributions from the operating company to service the holding company's US$350 million notes is critical to support Alinda Infrastructure Fund I LP's ownership of Reliance. Related Criteria And Research -- Criteria Guidelines For Recovery Ratings On Global Industrials Issuers' Speculative-Grade Debt, Aug. 10, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008 Ratings List Rating Assigned Reliance LP Reliance Intermediate Holdings LP Corporate credit rating BB+/Stable/-- Ratings Raised/Recovery Rating Assigned Reliance LP To From Senior secured notes BBB BBB- Recovery rating 1 Ratings Raised/Recovery Rating Revised Reliance Intermediate Holdings LP To From Senior secured notes BB BB- Recovery rating 5 4 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.