April 23 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has assigned Pendragon plc (Pendragon) Long-term and Short-term Issuer Default Ratings (IDR) of ‘B’ and a senior secured rating of ‘B+'. The Outlook on the Long-term IDR is Stable. Fitch has also assigned an expected rating of ‘B+(EXP)’ to the company’s GBP175m 2020 bond. The final rating on the notes is contingent upon the receipt of final documentation conforming to information already received. The proceeds of the notes will be used for refinancing existing debt, most of which matures in June 2014 and for general corporate purposes. The notes will constitute direct, secured and unconditional obligations of the issuer, Pendragon plc, and its guarantor subsidiaries.
Pendragon’s ratings reflect the company’s moderate business risk profile, characterised by a leading position in the fragmented UK auto retailing market, with long-term relationships with most of the large auto original equipment manufacturers (OEMs); offset by the company’s lack of geographic diversity (almost total dependence on the UK auto market) and vulnerability to the cyclical auto sector.
The ratings also reflect the group’s weak financial profile, with high adjusted leverage levels in excess of 4.5x, low operating margins of under 5% and moderate funds from operations (FFO) fixed charge coverage of under 2x. These ratios are only somewhat offset by adequate liquidity and financial flexibility. The ‘B+’ senior secured rating reflects Fitch’s recovery analysis of the company on a going concern basis, using an industry consistent multiple applied to an appropriately stressed EBITDA level, which derived a recovery band of 50% to 70% and a Recovery Rating of RR3 and lead to a one notch uplift from the IDR.
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 its franchise agreements with the OEMs give Pendragon territorial sales rights and provides it a relatively stable gross margin, Pendragon is also vulnerable to the financial health and / or strategy of the OEMs.
Highly Leveraged Capital Structure
Fitch adjusts Pendragon’s on-balance sheet reported debt and off-balance sheet operating lease obligations by adding the stock financing provided by third party finance providers not supplied by the financing arms of the auto OEMs. As such, the company’s reported gross and net FFO adjusted leverage at end-2012 was 4.8x and 4.5x, respectively. Fitch expects these ratios to remain stable in the short to medium term.
Cost Structure Flexibility
Given the low operating margins inherent in the vehicle sales business model, the structure and flexibility of the operating cost structure of Pendragon is important to offset the possibly volatile demand dynamics. Pendragon has relatively mid-ranging EBITDA margins exhibited in the sector, and since the downturn of 2008 and 2009, has improved its cost flexibility. Nevertheless, another sharp downturn in market demand could stress Pendragon’s financial profile.
UK Auto Market
Following the sharp market downturn in 2008 and 2009 in the UK, auto sales have stabilised in the past three years, but still remain a considerable amount below their 2008 peak. Given the sensitivity of earnings to volume movements, the outlook for auto sales remains a key indicator of future performance. A mitigating factor for Pendragon is its aftersales business, which is not highly cyclical and contributes close to 40% of the company’s gross profit.
Positive: Future developments that could lead to positive rating actions include:
- FFO adjusted leverage below 3x
- FFO fixed charge cover above 2.5x
- Free cash flow (FCF) above 1%
Negative: Future developments that could lead to negative rating action include:
- FFO adjusted leverage above 6x
- FFO fixed charge cover below 1.5x
- Negative FCF
- Failure to adequately re-finance the June 2014 debt maturities