China auto ABS motors ahead, despite bond slowdown
* Car-loan securitisations buck downbeat trend for corporate credit
Overview -- U.S. pet products and services retailer Petco is raising $550 million senior unsecured notes and will use these proceeds and about $75 million of cash to fund a dividend to its shareholders. -- We are assigning our 'B' corporate credit rating to Petco and a 'CCC+' issue-level rating with a '6' recovery rating to the proposed notes. -- We are also affirming all existing ratings on Petco Animal Supplies Inc., the direct subsidiary of Petco Holdings Inc. -- The stable outlook reflects our expectation that positive sales trends will continue to boost profit growth and spur some improvement of credit protection measures. Rating Action On Oct. 4, 2012, Standard & Poor's Ratings Services assigned its 'B' corporate credit rating to Petco Holdings Inc., the direct parent of Petco Animal Supplies Inc. At the same time, we assigned a 'CCC+' issue-level rating with a '6' recovery rating to Petco Holdings' $550 million senior secured pay-in-kind (PIK) option notes. Concurrently, we affirmed all existing ratings on Petco Animal Supplies, including our 'B' corporate credit rating. Although the proposed debt-financed dividend leads to a moderate deterioration of credit profile for Petco, our anticipation of good profitability gains provides cushion that supports the increased debt leverage. The company plans to use proceeds from the proposed notes, together with $75 million of cash from balance sheet, to fund an approximately $603 million dividend to its shareholders. Rationale The corporate credit rating on Petco reflects our assessment that the company's business risk profile will remain "fair" and its financial risk profile will remain "highly leveraged." The fair business risk profile reflects its position as the second-largest specialty pet goods retailer (after PetSmart), in a very fragmented industry. Petco's focus on convenience, product diversification, and customer service enabled it to gain market share from traditional supermarkets and discounters. However, we believe the industry remains highly competitive and online players are increasing their presence by offering convenience, competitive products, and attractive pricing. Although Petco's e-commerce segment continues to strengthen, it still represents a small portion of the company's business and online competition could hamper its current strong growth trend over the next couple of years. Growth of premium products offering, increasing private labels, and strong growth of services continue to propel profitability gains for Petco. Trailing-12-month ended July 28, 2012 revenue grew 10.8% over the same period last year. Benefits of sales leverage and improved efficiencies enhanced Petco's EBITDA margin to about 15.3% at Jul. 28, 2012, from 14.0% a year ago. Despite our view that prolonged economic weakness will continue to strain customer spending, we believe that favorable demographic trends will spur growth in the pet industry. As such, our projected performance for Petco in fiscal 2012 includes the following assumptions: -- Revenue growth of nearly 10%, reflecting mid-single-digit percent same-store sales increase and sales from newly opened stores; -- EBITDA margin remaining relatively stable at the current 15.3% as benefits of sales leverage will likely be offset by pricing strategies, higher operating expenses to support new store openings, and inflationary pressures; -- Capital spending at about 20% higher than in 2011 to support infrastructure investments and opening of about 80 net new stores; -- The company will likely pursue small acquisition to aid its expansion plans; and -- Free operating cash flow (FOCF) will remain positive despite higher interest payment related to additional debt and increased capital spending. We assess Petco's financial risk profile as highly leveraged. The proposed debt financed dividend results in a moderate deterioration of credit protection measures for the company. Pro forma for the transaction, total debt to EBITDA increases to 7.2x at July 28, 2012 from 6.1x before, and EBITDA coverage of interest weakens to 1.9x on a pro forma basis, from 2.2x at July 28, 2012. Funds from operations to total debt ratio also weakens to about 10.5% from about 12.8% before the debt addition. We anticipate that EBITDA growth will propel modest improvement of these measures, but credit ratios will likely remain indicative of a highly leveraged financial risk profile assessment over the next 12 months. Liquidity We view the company's liquidity as "adequate." Relevant aspects of the company's liquidity profile, based on our criteria, are as follows: -- We expect the company's sources of liquidity to exceed its uses by 1.2x or more over the next 12 months. -- We also expect net liquidity sources to be positive, even with a 15% decline in EBITDA. -- Petco has minimal debt maturities over the near term. -- The credit facility is "covenant-lite" and the company has to comply with the fixed-charge coverage covenant only if availability under its revolving credit facility is less than the greater of $25 million or 12.5% of the lesser of the commitments and the borrowing base. -- The company appears to have sound relationship with its banks. Following the proposed dividend payment, Petco's liquidity sources include about $30 million of cash at July 28, 2012, and availability under its $250 million asset-based revolving credit facility. Typically, Petco has about $40 million of letters of credit outstanding under the facility and no other amounts outstanding. We believe Petco will continue to generate positive FOCF despite increased cash interest payment and higher capital spending. Recovery analysis For the complete recovery analysis, see the recovery report on Petco, to be published as soon as possible on RatingsDirect following the release of this article. Outlook Our outlook on PETCO is stable and reflects our anticipation that positive sales trends will continue to benefit profitability and will enhance the company's credit profile. We anticipate modest improvement of credit measures, with leverage decreasing to about 6.9x at the end of fiscal 2012 and to the low-6x area in the following year. EBITDA coverage of interest will also improve to about 2.1x over the next year. Because these metrics are still characteristic of a highly leveraged financial risk profile, we do not anticipate a positive rating action in the next 12 months. In addition, the company's financial policies are very aggressive and due to its private ownership, the likelihood of future debt-financed dividends is high, in our view, and limits the potential for a higher rating in the near term. We could consider a lower rating if incremental debt to fund another dividend to the company's sponsors leads to leverage increasing over 8x. In such a scenario, based on our anticipation for EBITDA growth at the end of fiscal 2012, additional $500 million of incremental debt would likely trigger a downgrade. Related Criteria And Research -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List New Rating Petco Holdings Inc. Corporate Credit Rating B/Stable/-- $550M sr unsecd PIK toggle notes due 2017 CCC+ Recovery Rating 6 Ratings Affirmed PETCO Animal Supplies Inc. Corporate Credit Rating B/Stable/-- Senior Secured B Recovery Rating 3 Senior Unsecured CCC+ 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. Use the Ratings search box located in the left column.
* Car-loan securitisations buck downbeat trend for corporate credit
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