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May 14 (The following statement was released by the rating agency)
Fitch Ratings has assigned a rating of 'BBB-' to Signet UK Finance plc's proposed issue of $400 million 10-year senior unsecured notes. Fitch expects the new notes will be used to partly fund the announced acquisition of Zale Corporation (Zale) by Signet. Signet expects to fund the acquisition of Zale (announced in February 2014 and expected to close within calendar 2014) with $1.4 billion of debt, including approximately $600 million of receivables securitization.
The ratings of Signet UK Finance plc and the new notes reflect the consolidated credit profile of Signet Jewelers Limited (Signet), Signet UK Finance plc's indirect parent company. Signet and certain subsidiaries of Signet will fully and unconditionally guarantee the payment obligations of Signet UK Finance plc's new notes. The notes will be pari passu with all the existing and future unsecured and unsubordinated obligations at Signet and certain subsidiaries of Signet. A full list of ratings is provided at the end of this release.
KEY RATING DRIVERS
The ratings reflect Signet's and Zale's leading shares in the specialty jewelry market in the U.S. as well as the UK and Canada. Pro forma for the Zale acquisition, Signet generated $6.1 billion in revenue and roughly $770 million in adjusted EBITDA in fiscal 2014 ended January, and the combined entity operates over 3,650 stores. Fitch expects that Signet's retail adjusted leverage (as detailed below), will improve to under 3.5x by fiscal 2017 from a pro forma 3.75x, based on EBITDA of approximately $1 billion.
Kay Jewelers, Jared the Galleria Of Jewelry, and Zale hold a combined share of approximately 15% of the U.S. specialty jewelry market ($34 billion in industry sales in 2013 according to U.S. Census Bureau). Kay and Zale hold the number 1 and 2 market position in the U.S. mall-based specialty retail jewelry space, respectively, and Jared is the number 1 off-mall specialty retail jeweler. In addition, Zale is number 1 in Canada under its Peoples brand (4.2% of combined revenue) and Signet holds the leading market shares in the UK under its H.Samuel and the Ernest Jones brands (11.3% of combined revenue).
Signet has generated strong top-line and EBITDA growth since the recession, driven by the growth of the specialty jewelry industry of 3% annually over the past five years; continued industry consolidation; and the company's strong execution of its growth initiatives. The expanded retail footprints of its strong concepts such as Kay and Jared, restructuring of regional brand stores, increasing penetration of its exclusive brand portfolio (representing approximately 31% of total U.S. sales in fiscal 2014) and increasing vertical integration of its supply chain have helped drive mid-to-high single-digit growth in same store sales and EBITDA margin improvement to 16.5% in fiscal 2014 from 9.7% in fiscal 2008.
Zale has underperformed historically, but has been in a turnaround mode since 2010 and turned profitable in 2013 on a net income basis for the first time since 2008 (on EBITDA of $76 million or EBITDA margin of 4%). Fitch expects Signet's acquisition of Zale will provide the latter the necessary capital to invest in its stores and systems and bring expertise in supply chain and expense management.
Fitch expects Signet on a standalone basis will continue to generate mid-single-digit top-line growth over the next two to three years, driven by comps growth in the 4% range and modest contribution from store expansion. Zale-related brands are expected to grow 2.5% to 3% mainly on same store sales, offset by some modest square foot reduction of underperforming stores. As a result, consolidated EBITDA is expected to grow to approximately $1 billion by fiscal 2017 from a current combined $770 million.
Pro forma consolidated adjusted debt/EBITDAR at the end of fiscal 2014 (ended January) was at 4.4x for the combined company, assuming total debt issuance of $1.4 billion. Fitch expects the consolidated leverage ratio to improve to the high 3x range by the end of fiscal 2017.
Fitch's assessment of Signet's credit profile incorporates a retail adjusted leverage. Fitch notes that Signet is one of a select group of retail companies that still own their credit card receivables and assigns a portion of the company's debt to the more highly leveraged credit card business. This is consistent with Fitch's practice of treating debt for companies that fund their own credit card receivables.
Fitch assumes Signet's credit card receivables could be financed using a mix of 70% debt and 30% equity which translates into $1 billion in credit card-related debt based on Signet's fiscal 2014 receivables of $1.4 billion. This would include the forthcoming issuance of a $600 million ABS facility. Retail-related debt therefore is composed of corporate debt that is not allocated to the credit card business and leases capitalized using 8.0x rent expense.
Implicit in this assumption is that if Signet ever sold its receivables portfolio, it would pay down debt directly secured by credit card receivables as well as allocated unsecured corporate debt to a level consistent with Fitch's assumption. As a result, core retail debt/EBITDAR on a pro forma basis was 3.75x at the end of fiscal 2014 and is expected to improve to under 3.5x by fiscal 2017.
Signet had $250 million in cash at the end of fiscal 2014 and no borrowings under its $400 million unsecured revolving credit facility. The company has generated positive free cash flow (FCF) over the past four years, although the amount declined to $37 million in fiscal 2014, versus an average of $200 million in fiscal 2011 to fiscal 2013. This was the result of higher working capital needs particularly to support increased credit sales, higher capex to fund store growth, as well as the institution of dividends since fiscal 2012. Fitch expects the company to be FCF positive post the first full year of the Zale acquisition.
A positive rating action could result in the event of better than expected top-line and profitability trends and/or higher than expected debt reduction that would lead to retail adjusted leverage of under 3x.
A negative rating action could result in the event of one or more of the following: (i) worse than expected top-line and profitability trends, (ii) execution issues related to the Zale acquisition that impede the company from realizing stated synergies or improving the profitability at acquired units, and (iii) the inability to reduce retail adjusted leverage below 3.5x by the end of fiscal 2017.
Fitch rates Signet UK Finance plc as follows:
--Long-term Issuer Default Rating (IDR) 'BBB-';
--Senior unsecured debt securities assigned 'BBB-'.