TEXT - S&P raises Ethan Allen Interiors to 'BB-'
Overview -- U.S.-based home furnishings company Ethan Allen Interiors Inc. has continued to improve its credit measures and operating performance over the past year. -- We are raising the corporate credit rating on Ethan Allen to 'BB-' from 'B+'. The 'BB-' issue-level rating on the company's senior unsecured notes remains unchanged, although we revised the recovery rating to '3' from '2'. -- The outlook is stable, reflecting Ethan Allen's improving operating trends and our expectation that the company will continue to gradually improve credit measures and maintain adequate liquidity. Rating Action On Dec. 14, 2012, Standard & Poor's Ratings Services raised its corporate credit rating on Danbury, Conn.-based Ethan Allen Interiors Inc. to 'BB-' from 'B+'. The issue-level rating on the company's senior unsecured notes remains a 'BB-', while we revised the recovery rating to '3' from '2'. While a '3' recovery rating generally reflects our expectation of recovery in the 50%-70% range in the event of default, our recovery analysis suggests much higher recovery for Ethan Allen's notes. However, given the change in corporate credit rating to 'BB-', we cap the recovery rating for the unsecured notes at '3' because the company has the potential to incur secured debt in a distressed situation. Rationale The ratings on Ethan Allen reflect our opinion of the company's "significant" financial risk profile and "weak" business risk profile. Key credit factors in our assessment include the company's good brand awareness, strong retail distribution network, exposure to the highly competitive residential furnishings industry, and vulnerability to reduced discretionary spending in an economic downturn. We believe the potential for slowing economic conditions and continued weakness in the housing market remains a risk to further operating performance improvement. Ethan Allen is one of the largest manufacturers and retailers of home furnishings and accessories in the U.S. As a vertically integrated company, Ethan Allen designs, manufactures, sources, distributes, and sells a full range of home furnishings under the well-recognized Ethan Allen brand. The company's products are sold through a dedicated international network of over 300 retail stores, which we believe provides a competitive advantage. The company maintains a leading market position with a strong brand, yet participates in the highly fragmented residential furnishings industry. Additionally, housing market weakness and reduced consumer spending on furniture significantly depressed sales during the most recent recession. Sales declined by over 12% and over 31% for the fiscal years ended June 2010 and June 2009, respectively, before improving by 15% in fiscal 2011. Sales for the 12 months ended Sept. 30, 2012, were up about 4.7%, due to Ethan Allen's marketing initiatives, a wide range of new product introductions, an increase in the number of interior designers and other retail associates, the continued repositioning of its retail network, and improving consumer confidence. Manufacturing inefficiencies and a sharp decline in demand for the company's products pressured margins during the most recent recession in the U.S., but results have significantly improved in recent quarters. For the 12 months ended Sept. 30, 2012, we estimate adjusted EBITDA improved more than 16% from the previous-year period, yet still remains about 40% below the levels achieved prior to the most recent recession. Similarly, EBITDA margins for the 12 months ended Sept. 30, 2012, have increased to 11.7%, from 10.5% in the previous-year period, yet remain well below prerecessionary levels of around 15%. However, the company's results are benefiting from sales growth and the consolidation of its manufacturing, logistics, and distribution operations, as well as other cost-reduction actions taken in recent years. We believe EBITDA margins could continue to improve over the next year, as the company continues to realize the benefits of its expense reduction initiatives and improvements in manufacturing efficiencies. Credit protection measures have shown substantial improvement in recent quarters, reflecting improved profitability and a post-recession volume recovery, as well as debt reduction. For the 12 months ended Sept. 30, 2012, we estimate the ratio of total lease-adjusted debt to EBITDA improved to about 3.4x, from 4.1x in the previous-year period, while funds from operations (FFO) to adjusted debt was 27% compared to 24.7%. We believe these improved credit measures are consistent with indicative ratios for a "significant" financial risk profile, which include leverage of 3x-4x and FFO to debt of 20%-30%, and will continue to modestly improve over the next year. Our forecast assumptions include: -- Ethan Allen's sales will increase at a mid-single-digit rate in fiscal 2013, as the economy and consumer spending environment continues to recover. -- Adjusted EBITDA margins will improve by about 50 basis points, reflecting improving manufacturing efficiencies, volume leverage, and reduced promotional expenses. -- Modest reduction in capital expenditures to about $20 million, from $22 million in fiscal 2012. Based on our forecast, we estimate that by the end of the fiscal year ending June 2013, adjusted leverage will be close to 3x and FFO to total debt will remain close to 27%. We forecast FFO will be more than $55 million for fiscal 2013. Liquidity We believe Ethan Allen has "adequate" liquidity to meet its needs over the next year. This is based on the following information and assumptions: -- We expect liquidity sources (including cash, discretionary cash flow, and revolving credit availability) to exceed uses by more than 1.2x over the next 12 months. -- We expect net sources to be positive, even if there were a 15% drop in EBITDA. -- As of Sept. 30, 2012, Ethan Allen had cash and marketable securities of $84.6 million, restricted cash and investments of $15.4 million, and availability of $49.4 million on its $50 million revolving credit facility, which is subject to a borrowing base calculation. -- The only financial covenant is a minimum fixed-charge coverage ratio that applies if borrowing availability is less than $7.5 million. -- Ethan Allen historically has not borrowed on its revolver, and indicated it currently has no plans to use the facility other than to support standby letters of credit, which currently total less than $1 million. -- Ethan Allen has minimal near-term debt maturities, and we estimate the company will generate FFO of more than $55 million over the next 12 months. Recovery analysis The issue-level rating on Ethan Allen Global's 5.375% senior unsecured notes due 2015 is 'BB-', the same as the corporate credit rating on parent company Ethan Allen Interiors Inc. The recovery rating is a '3', which is the cap for our recovery ratings for companies with a 'BB-' or higher corporate credit rating. (The company's $50 million asset-based loan revolver is not rated.) For the complete recovery analysis, see the recovery report on Ethan Allen to be published following this report on RatingsDirect. Outlook Our rating outlook on Ethan Allen is stable. We expect Ethan Allen to further improve operating performance and credit measures as its business continues to recover, and sustain adjusted leverage below 4x in order to maintain the ratings. Although unlikely over the near term, we could consider a higher rating if operating performance continues to improve such that the company is able to sustain its recent improvement in operating performance, and further improve credit measures, including reducing adjusted leverage well below 3x and increasing FFO to debt above 30%. We estimate the company could achieve this credit measure improvement in a scenario where sales increase by more than 5% and EBITDA margins improve by 150 basis points over the end of fiscal 2012. We could lower the ratings if operating performance weakens such that adjusted leverage exceeds 4.5x. We believe this could occur in a scenario in which sales declined by 10% and EBITDA margins contracted by 200 basis points from the levels at the end of fiscal 2012, perhaps due to weakening economic conditions and a decline in consumer spending combined with increased input cost inflation. Related Criteria And Research -- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Key Credit Factors: Business And Financial Risks In The Branded Consumer Products Industry, Sept. 10, 2008 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Upgraded To From Ethan Allen Interiors Inc. Corporate credit rating BB-/Stable/-- B+/Stable/-- Issue rating affirmed; recovery rating revised Ethan Allen Global Inc. Senior unsecured BB- BB- Recovery rating 3 2