TEXT-S&P revises Prestige Brands outlook to stable from negative
Overview -- Prestige Brands' pro forma financial ratios have improved as the company has increased operating income and applied free cash flow to debt reduction following its acquisition of GlaxoSmithKline's (GSK) North American over-the-counter (OTC) brands in early 2012. -- We are affirming all ratings, including the 'B+' corporate credit rating, and revising the outlook to stable from negative. -- The outlook is stable, which reflects our expectation that recent pro forma credit ratio improvement will continue, with credit protection measures remaining in line with our indicative ratios for an "aggressive" financial risk profile. Rating Action On Dec. 20, 2012, Standard & Poor's Ratings Services affirmed its 'B+' corporate credit rating on Irvington, N.Y.-based Prestige Brands Inc. and revised the outlook to stable from negative. At the same time, we affirmed the 'BB-' issue-level ratings (one notch higher than the corporate credit rating) on the company's $660 million senior secured term loan due 2019 and the $250 million senior secured notes due 2018. The recovery ratings remain '2', indicating our expectation for substantial (70% to 90%) recovery in the event of a payment default. In addition, we affirmed the 'B-' issue-level rating (two notches below corporate credit rating) on the company's $250 million new senior unsecured notes. The recovery rating remains '6', indicating our expectation for negligible recovery (0-10%) in the event of payment default. Rationale The outlook revision reflects our expectation that Prestige Brands will continue to strengthen its credit measures through the end of fiscal 2013 and in fiscal 2014. During this time we expect operating performance will remain steady and the company will further apply free cash flow to debt repayment. The company has improved credit measures faster than our previous forecast, which includes a pro forma ratio of total debt to EBITDA of about 4.8x; our earlier projection called for leverage to fall below 5x by the end of fiscal 2013 (ended March 31, 2013). We now believe leverage will be in the low-4x area by the end of fiscal 2014. The ratings on Prestige Brands reflect our view that the company's financial risk profile will remain "aggressive" over the next year. We believe credit metrics will remain weak and that the company will continue to maintain its financial policy for the foreseeable future, actively pursuing an acquisition-based growth strategy and utilizing debt as its primary source to fund such transactions. We continue to view the company's business risk profile as "weak" because of the company's niche position in a highly competitive OTC health care and household consumer products market. At the same time, we view Prestige's management and governance to be "fair." Our assessment recognizes management's demonstrated ability at integrating its recent acquisitions without material disruption to date. Prestige acquired many of its brands from larger competitors who underinvested in them because of the brands' limited potential to expand globally. The company's strategy is to develop new product innovations for these brands and, with increased marketing spending, boost performance, most notably with respect to its core OTC brands. We believe Prestige's credit metrics will further improve over the next year as the company continues to increase cash flow generation and benefit from its recently acquired OTC brands. Nevertheless, we expect credit measures over the next year to remain weak and to be in line with our indicative ratios for an aggressive financial risk profile, including a ratio of funds from operations (FFO) to total debt between 12% and 20% and leverage between 4x and 5x. Our forecast assumes slow economic growth in the U.S. in 2013, which includes 2.1% GDP growth in 2013. Specifically, our forecast over the next 12 months for credit metrics includes the following outcomes: -- Leverage (the ratio of adjusted debt to EBITDA) in the high-4x area -- EBITDA coverage of interest expense approaching 3x; and -- FFO to total debt in the 11%-12% percent area. The above forecast is based on the following assumptions: -- Low-single-digit sales growth over the next two years, which assumes low-single-digit increases in existing and acquired OTC brands more than offsetting a mid-single-digit continued decline in its Household business. -- We forecast consolidated EBITDA margins will remain close to 35% during this time, compared with an EBITDA margin of just over 30% for the fiscal year ended March 31, 2012. We base this forecast on the belief that the company has benefited from a favorable mix shift, as the acquired GSK brands carry higher operating margins, and as increases in brand spending help propel sales growth. -- Acquisition activity will be somewhat limited to smaller "bolt-on" opportunities over the next two years. We do expect Prestige Brands to acquire niche brands to pursue growth. -- We expect the company to continue to apply free cash flow to debt reduction over the next two years. Our view of the company's business risk profile is based on its lack of international diversity in its product lines and its participation in the highly competitive OTC health care and household consumer products segments, where it competes with much larger and better capitalized companies with greater resources for product development and marketing, including Johnson & Johnson and Procter & Gamble. The company benefits from strong market shares with high-margin brands and established positions in niche markets. In addition, we believe the company's recent string of acquisitions provide greater negotiating leverage with its key retail customers and an increased geographic presence in Canada. We believe Prestige Brands has maintained good profitability, with good operating performance in its OTC business offsetting declines in its Household segment. We believe Prestige Brands has relatively good operating efficiency, focusing on the marketing and development of its brands, and outsourcing manufacturing to third parties. Although Prestige Brands is involved in developing new product innovations, the company also outsources research and development to third parties. This helps reduce Prestige Brands' expenses; however, it also potentially limits the company's control of new product development. Most of its existing brands, such as Compound W, Clear Eyes, and Chloraseptic, are well established and have strong market positions in their niche categories. Following the GSK OTC brands acquisition, the company has 14 core OTC brands, nine of which have sales in excess of $20 million. Liquidity We believe Prestige Brands will maintain "adequate" liquidity to meet its needs, as we expect the company's sources to be greater than its uses over the next 12 to 18 months. Liquidity sources include about $29 million of cash and equivalents as of Sept. 30, 2012, and under its $75 million asset-backed (ABL) revolving credit facility due in January 2017, which was upsized from $50 million in September 2012; $25 million was drawn at Sept. 30, 2012. Additional cash sources include free operating cash flow generation, which we estimate will range between $80 million and $100 million in fiscal 2013. Uses include seasonal working capital needs, modest capital expenditures, and potential tuck-in acquisitions. Relevant aspects of Prestige's liquidity, in our view, are as follows -- We expect coverage of uses by sources to be in excess of 1.2x for the next two years. -- We expect sources to exceed uses, even if EBITDA drops 20%. -- Cushion on the company's minimum consolidated net cash interest coverage covenant and maximum total net leverage covenant to remain above 15% through 2013 -- No material near-term maturities -- We believe the company maintains a satisfactory standing in credit markets. Recovery analysis The issue-level rating on Prestige Brands' $660 million senior secured term loan due 2019 is 'BB-' (one notch higher than the corporate credit rating; $565 million was outstanding as of Sept. 30, 2012). The recovery rating on the secured debt is '2', indicating our expectation for substantial (70% to 90%) recovery in the event of a payment default. The $50 million senior asset-based revolving credit facility due 2017 is not rated. The issue rating on the company's $250 million senior secured notes due 2018 is also 'BB-', reflecting improved recovery prospects for lenders resulting from the addition of collateral in conjunction with the roll-over of this debt. The recovery rating on these notes is '2'. The company's $250 million of senior unsecured notes is rated 'B-' (two notches below the corporate credit rating), with a recovery rating of '6', indicating our expectation for negligible recovery (0%-10%) in the event of a payment default. For the complete recovery report on Prestige Brands, please see the recovery report on Prestige Brands Inc., published Jan. 26, 2012 on Ratings Direct. Outlook The rating outlook is stable. We believe Prestige Brands' credit protection measures will gradually improve over the next two years given the successful integration of the GSK brands and our expectation for continued debt reduction over the next 12 months. We still expect credit metrics to remain in line with indicative ratios for our "aggressive" financial descriptor. We could consider raising the rating if Prestige is able to generate modest organic sales growth, maintain its EBITDA margin close to current levels, and reduce and sustain an adjusted leverage ratio below 4x, which is more indicative of a "significant" financial risk profile. Based on pro forma EBITDA levels, we estimate leverage would approach this threshold or below if the company reduced debt by more than $175 million. We estimate this could occur if the company sustains organic sales at a low-single-digit percentage rate, while maintaining EBITDA margins close to 35% and applying much of its free cash flow to debt reduction. Alternatively, we could lower the rating if credit measures weaken as a result of a more aggressive financial policy or performance declines, either of which could cause leverage to exceed 5.5x. Based on current pro forma credit measures, we estimate an increase in debt of about $175 million or more (at current pro forma EBITDA as of Sept. 30, 2012) would cause leverage to exceed this level, or a decline in pro forma EBITDA of about 13% or more (assuming current debt levels) would also lead to leverage exceeding this level. We believe further declines in the company's household segment coupled with failure to improve organic sales in its OTC segment (despite higher advertising and promotional brand support) would cause profitability to weaken. 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 -- Key Credit Factors: Criteria For Rating The Global Branded Nondurable Consumer Products Industry, April 28, 2011 -- Corporate Criteria: Analytical Methodology, April 15, 2008 -- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008 Ratings List Rating Affirmed; Outlook Revised To From Prestige Brands Inc. Corporate credit rating B+/Stable/-- B+/Negative/-- Ratings Affirmed Prestige Brands Inc. Senior secured Notes BB- Recovery rating 2 Bank loan BB- Recovery rating 2 Senior unsecured Notes B- Recovery rating 6 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. 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