TEXT - S&P cuts American Tire Distributors Inc to 'B'
Overview -- The company continues to expand: net sales grew 10% in the third quarter, compared with the same quarter a year ago, due to new distributions centers, acquisitions, and higher tire pricing. -- The company's expansion has led to a significant (and we think sustained) increase in leverage that falls outside our expectations for the 'B+' rating. -- Consequently, we are lowering the corporate credit rating on American Tire Distributors to 'B' from 'B+'. The outlook is stable. -- We are also lowering the rating on the company's senior secured notes to 'CCC+' from 'B-'. The recovery rating on this debt remains '6'. Rating Action On Nov. 20, 2012, Standard & Poor's Ratings Services lowered its corporate credit rating on Huntersville, N.C.-based American Tire Distributors Inc. (ATD) to 'B' from 'B+'. The outlook is stable. At the same time, we lowered the rating on the company's senior secured notes to 'CCC+', two notches below the corporate credit rating, from 'B-'. The recovery rating on this debt remains '6', indicating our expectation of negligible recovery (0%-10%) for noteholders in the event of default. Rationale The downgrade reflects Standard & Poor's view that ATD's leverage falls outside our expectation for the 'B+' corporate credit rating--and will continue to do so given ample expansion opportunities in this fragmented industry. We view the company's financial risk profile as "highly leveraged" under our criteria, and we expect ATD's leverage to remain about 6x by the end of the year. We view ATD's business risk as "weak," reflecting its limited geographical diversity, fierce competitive landscape, and narrow scope of operations. Still, at the same time, we believe the company's relative size advantage allows it to carry the industry's broadest product line, deliver items more efficiently than its competitors, and spend less, as a percentage of sales, than its competitors to invest in information systems. In addition, although ATD sells economy-brand tires, the company's sales mix is focused on high-margin products such as high- and ultra-high-performance tires, flag brands, and large-rim-diameter products. Private-equity company TPG Capital L.P. acquired privately held ATD in 2010. ATD is the largest wholesale distributor of passenger-car and light-truck tires to the $32 billion U.S. replacement tire market. It operates 102 distribution centers, serving about 60,000 customers. Most are independent tire dealers, which make up the largest channel for replacement tire sales. The only tire distributor with a national presence, the company competes in the Southeast, Mid-Atlantic, Midwest, West, Southwest, and in the Northeast. However, because the market is highly fragmented, ATD's national market share is only about 10%. No one customer accounts for more than 2% of sales, which reduces customer credit risk exposure. A key dimension of ATD's strategy is to expand geographically by making acquisitions. Additionally, we believe the company takes advantage of acquisition opportunities to saturate its current markets. ATD has also been increasing sales by penetrating the auto dealership sales channel. It also has been focusing directly on consumers through its TireBuyer.com Web site, which shows a wide range of products, enables consumers to locate nearby tire retailers in ATD's network, and provides the total cost of the purchase, including installation fees. We believe the company's business strategy should continue to increase profitability and deliver fairly stable operating performance. In the third quarter of 2012, the company generated $915 million in revenue, up 10.2% from the same period one year ago. The opening of new distribution centers and the acquisition of Consolidated Tire & Oil and North Central Tire contributed $41.9 million to sales in the quarter and net pricing contributed $37.2 million. ATD's gross margin in the third quarter was 16.3%, up slightly compared with a third-quarter gross margin of 16% a year ago, mostly because of better price mix. Operating income in the quarter was $19.6 million, compared with $20.2 million in the same quarter of 2011. For the 12 months ended Sept. 29, 2012, adjusted EBITDA was $173.3 million, compared with adjusted EBITDA of $168.6 million a year ago. The adjusted EBITDA margin was down to 5.1%, compared with 5.9% one year ago. Adjusted debt to EBITDA was higher at 6.8x, compared with 6.4x one year ago, but we expect increasing EBITDA to result in adjusted debt to EBITDA to about 6x by the end of 2012. Liquidity We believe ATD has adequate sources of liquidity to cover its needs in the near term, even in the event of an unforeseen EBITDA decline. Our assessment of the company's liquidity incorporates the following expectations and assumptions: -- We expect ATD's sources of liquidity, including cash and facility availability, to exceed uses by 1.2x or more over the next 12 to 18 months. -- We expect net sources to remain positive, even if EBITDA declines more than 15%. -- Because of ATD's good conversion of EBITDA to discretionary cash flow, we believe it could absorb low-probability, high-impact shocks. Liquidity sources as of Sept. 29, 2012, include cash and equivalents of $14.8 million and availability of $179.7 million under the company's $650 million asset-backed revolving credit facility, which is subject to a borrowing base. The facility expires on June 6, 2016. Peak borrowing needs typically occur in the first half of the year because of seasonal demand fluctuations. Because ATD is a distributor, its capital expenditures are minimal (currently about 1% of annual revenue) in our opinion, but working capital investment can be a significant use of cash seasonally, as can growth. We expect the company to generate positive free cash flow in 2013. Debt maturities are limited in the next few years; $250 million in 9.75% senior secured notes are due 2017, and $200 million in 11.5% senior subordinated notes are due in 2018. Recovery analysis For the complete recovery analysis, please see Standard & Poor's upcoming recovery report on American Tire Distributors Inc., to be published on RatingsDirect. Outlook Our stable outlook on ATD reflects the likelihood that the company will maintain credit measures in line with the new rating: namely, adjusted leverage between 5x and 6x. We do not expect the company to generate positive free cash flow in 2012 in part because of rising working capital requirements related to its geographic expansion. Our view of free cash flow in 2013 is based upon the assumption that the private equity owners will manage growth to prevent further increases in debt. We could raise the rating if the economy continues to grow and the company slows the pace of its greenfields and acquisitions, thereby allowing the benefits of its expansion to be reflected in its credit measures. Specifically, we expect that the company would bring adjusted leverage to 5x or less due to better-than-expected EBITDA, and generate sustained positive free cash flow. We are, however, unlikely to raise the rating above 'B+', given the private-equity ownership and potential for an eventual recapitalization or sale to another financial sponsor. We could lower the rating if ATD's profitability worsens because of rising costs and declining demand for replacement tires, and if we believe leverage could move significantly above 6x. This could occur if revenue in 2013 fell more than 5% and gross margins moved below 16%. We could also lower the rating if ATD substantially increased the pace of its debt-financed expansion and generated significant negative free cash flow. Related Criteria And Research -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009 -- Key Credit Factors: Business And Financial Risks In The Auto Component Suppliers Industry, Jan. 28, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Downgraded To From American Tire Distributors Inc. Corporate credit rating B/Stable/-- B+/Stable/-- Senior secured CCC+ B- Recovery rating 6 6