Overview -- Office supplies retailer Staples Inc. announced that it will tender for up to $750 million of its 9.75% notes due in January 2014 and will fund the offer with proceeds from a $1 billion senior unsecured note issuance. -- On a pro forma basis, we expect the transaction to modestly increase debt leverage, but also lower cash interest costs. -- While the company's profits were down in the third quarter, its domestic business showed signs of stability, which we expect to continue. -- We are affirming all ratings, including the 'BBB' corporate credit rating, and assigning 'BBB' ratings to the company's senior unsecured notes. -- The stable outlook incorporates our expectation that operating trends should stabilize in 2013, allowing Staples to maintain credit ratios near current levels. Rating Action On Jan. 8, 2013, Standard & Poor's Ratings Services affirmed the ratings on the Framingham, Mass.-based Staples Inc., including the 'BBB' corporate credit rating. At the same time we assigned a 'BBB' issue-level rating to the company's senior unsecured note issuance. This action comes after the company issued $1 billion of senior unsecured notes. The company plans to use most of the proceeds to fund a tender offer of up to $750 million of the company's 9.75% notes due January 2014. Rationale The ratings on Staples reflect Standard & Poor's Ratings Services' opinion that the company will maintain its "satisfactory" business risk profile, as the company is the No. 1 provider of office products in North America and has a strong competitive position in its delivery business. We view Staples' financial risk profile as "intermediate" and expect its credit measures to remain near current levels and its operating trends to stabilize. Moreover, the company maintains a "conservative" financial policy, in our view, and could use excess cash flow to further reduce debt and enhance credit protection measures. The transaction will increase debt leverage slightly to about 2.2x from 2.1x as of Oct. 27, 2012. However, we also expect that cash interest costs could decline by up to $30 million, leading to adjusted EBITDA coverage of interest of about 5.5x, an improvement from 5.2x over the past 12 months. Staples' performance exceeded our expectations in the third quarter with an adjusted EBITDA decline of only about 5%, which is a marked improvement from the second quarter when adjusted EBITDA fell about 16%. We expect a similar EBITDA decline in the fourth quarter. We believe that Staples' performance should stabilize during 2013, despite weak economic growth and industry conditions, as a result of several supporting factors, including modest market share gains based on a more aggressive strategy in its North American delivery business. We believe Staples' cost structure and service advantages relative to its competitors and enhanced product offerings and services will help it gain customers and boost its business delivery segment. In addition, the company's elimination of cost redundancies, restructuring of its international operations, and continued reduction in average store size should further support performance. In the fourth quarter of 2012, we expect moderate sales and profit declines. For fiscal 2012, we expect adjusted EBITDA of about $2.4 billion. Our forecast for 2013 includes the following assumptions: -- A modest 1% sales growth, with improving U.S. operations helping to offset declines in Europe. -- Adjusted EBITDA margins will be in the mid-9% area. The company is implementing cost-cutting initiatives, which we think will mitigate profit challenges in foreign markets. -- Relatively flat EBITDA in 2013 relative to 2012. -- Cash flow generation will remain sound with free cash flow near $1 billion and that the company could repay the remaining January 2014 maturity with excess cash. Based on our forecast, we believe Staples' credit ratios will be near these levels throughout 2013: -- Adjusted debt to EBITDA in the 2.2x-2.3x. -- EDITDA coverage of interest in the high 5x. -- Funds from operations (FFO) to debt to be in the high-30% area. Our ratings incorporate our view that the company would not incur sizable debt to fund shareholder initiatives or business growth initiatives, and it would maintain credit metrics consistent with our assessment of an intermediate financial risk. Liquidity We view Staples liquidity as "strong" as we expect sources to exceed uses by a ratio of at least 1.5 to 1 over the next 24 months. As of Oct. 27, 2012, Staples' sources included about $1 billion in cash, just under $1.2 billion of credit line availability, and an expected $1.4 billion of FFO over the next year. Staples' uses, after the transaction, include capital spending of around $400 million, the remaining $750 million of unsecured notes maturing in Jan of 2014, and moderate uses for working capital. Other relevant aspects of Staples' liquidity profile are as follows: -- We estimate Staples has full availability under its $1 billion revolving credit facility due November 2014. -- We believe the company would remain in compliance with its revolving credit facility financial covenants, even if EBITDA fell 30%. -- We anticipate the company has manageable maturities and can fund the remaining January 2014 maturity with excess cash. -- We believe the company has sound banking relationships and a satisfactory standing in credit markets. -- We believe Staples' will generate about $1 billion of annual free cash flow will that will likely be used for a mix of dividends, share repurchases, and potentially bolt-on acquisitions. Outlook The outlook is stable. We believe profits should be steady in 2013 and credit measures should remain near current levels. We forecast adjusted EBITDA margins in the mid-9% area, leverage in the low-2x area, and FFO to debt in the high-30% area. We think management will continue to fund shareholder initiatives and business growth plans in a manner consistent with an intermediate financial risk. However, we acknowledge the potential for moderate profit pressure from weak global industry demand and intensifying competition over the next year. We could take a negative rating action if we revised our business risk assessment of Staples to "fair" from "satisfactory". We would likely do so if the operating trends in the U.S. worsened in 2013, and resulted in mid-single-digit revenue and high-single-digit profit declines in Staples' domestic divisions. If this were to occur, adjusted EBITDA would be in the $2.2 billion area. Under these circumstances, we may consider a lower rating because of continued declines in the company's profits, despite credit ratios that could still be commensurate with an intermediate financial risk profile. Note that if we revise the outlook to negative at the current 'BBB' rating, the 'A-2' short-term and commercial paper ratings could also be in jeopardy. We believe the economic headwinds that face Staples' markets is a key risk factor that limits upgrade potential in the near term. Still, we could raise the ratings if the company's Eurozone business stabilizes and it pursues consistent growth opportunities in the U.S. If we believe Staples can sustain leverage near 1.8x and FFO to debt in the high-40% area, we could raise the rating. We estimate this could occur if sales and EBITDA grow by a high-single-digit rate in 2013, and the company pays off the remaining $750 million unsecured note maturity in January 2014. Related Criteria And Research -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008 -- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008 Temporary contact number: Charles Pinson-Rose (917-280-6289) Ratings List Ratings Affirmed Staples Inc. Corporate Credit Rating BBB/Stable/A-2 Senior Unsecured BBB Commercial Paper A-2 New Rating Staples Inc. Senior Unsecured Notes Due 2018 And 2023 BBB 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.
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