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April 30 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has affirmed UK-based Pendragon plc's (Pendragon) Long- and Short-term Issuer Default Ratings (IDR) at 'B' and its senior secured rating at 'B+'. The Outlook on the Long-term IDR is Stable.
Relationships with Auto OEMs
A significant driver of Pendragon's operations and financial performance is driven by its relationships with the various auto OEMs from which it sources vehicles. While a franchise agreement with an OEM gives a retailer territorial rights to sell a certain brand and provides with a stable, and non-cyclical, gross margin, a retailer is also vulnerable to the financial strength and / or strategy of the OEMs.
Cost Structure Flexibility
Given the low operating margins inherent in the vehicle sales business model, the flexibility of the operating cost structure of Pendragon is important to offset possibly volatile demand dynamics. To this end, the company benefits from mid-range EBITDA margins, and since the downturn of 2008 and 2009, has improved its flexibility. Nevertheless, another sharp downturn in market demand would likely lead to considerable stress on Pendragon's financial profile.
UK Auto Market
Following the sharp market downturn in 2008 and 2009 in the UK, auto sales have rebounded in the past two years, but still remain considerably below their 2008 peak. Given the sensitivity of earnings to volume movements, the outlook for auto sales remains a key indicator of future performance.
Highly Leveraged Capital Structure
As well as bank debt and other on-balance sheet instruments such as finance leases, Pendragon has considerable off-balance sheet operating lease obligations, which together totalled GBP546m at end-2013. Fitch also adjusts debt by adding the portion of stock financing provided by third-party institutions (GBP150m at end-2013), as opposed to other manufacturers whose stock financing is not treated as debt. In Fitch's view stock financing mirrors debt in nature, and would likely be replaced by other forms of bank debt were it to stop being available. This adjustment has the effect of raising leverage by around 0.9x. This meant that Fitch-adjusted gross and net leverage ratios at end-2013 were 4.2x and 3.9x, compared with 4.9x and 4.5x at end-2012.
Positive: Future developments that could lead to positive rating actions include:
- FFO adjusted leverage below 3x (FY13: 4.2x) on a sustained basis
- FFO fixed charge cover above 2.5x (FY13: 2.1x) on a sustained basis
- Free cash flow (FCF) above 1% (FY13: 1.5%) on a sustained basis
Negative: Future developments that could lead to negative rating action include:
- FFO adjusted leverage above 6x on a sustained basis
- FFO fixed charge cover below 1.5x on a sustained basis
- Negative FCF on a sustained basis