-- Atlanta-based industrial distributor HD Supply Inc. is offering $750
million of new senior unsecured notes and we expect it to use the proceeds to
redeem a portion of its outstanding subordinated notes due 2015.
-- We are assigning a 'CCC+' issue-level rating to the proposed senior
unsecured notes with a recovery rating of '6'.
-- We are affirming our 'B' corporate credit rating on the company.
-- The stable outlook reflects our expectation that HD Supply's operating
performance will sustain over the next year.
On Oct. 9, 2012, Standard & Poor's Ratings Services affirmed all its ratings
on HD Supply Inc., including its 'B' corporate credit rating. The outlook is
stable. At the same time, we assigned a 'CCC+' issue-level rating and a '6'
recovery rating to the company's proposed $750 million senior unsecured notes
due 2020. The '6' recovery rating indicates expectations for negligible (0% to
10%) recovery in the event of default.
The ratings on privately owned HD Supply reflect the company's "satisfactory"
business risk profile as a major industrial distributor of infrastructure and
energy, maintenance, repair and improvement, and specialty construction
products. The rating also reflects the company's "highly leveraged" financial
risk profile and the impact on its operating performance arising from the
protracted weakness in U.S. construction activity. However, the company's
business-line diversity, leading market positions, and operational scale to
weather the construction downturn partly offset these factors. Although we
remain uncertain about the potential recovery in the construction cycle, HD
Supply continues to expand its share of sales in the maintenance, repair, and
operations (MRO) and infrastructure markets, and reduce the effect of the weak
construction markets on its near- to intermediate-term operating performance.
Its capital structure has almost $6 billion of funded debt.
HD Supply's operations improved in the first half of the fiscal year,
including a 12% increase in sales and a 29% increase in EBITDA, with good
performance sequentially through the past fiscal year despite still-weak end
markets. Although we expect certain end markets, including construction, to
remain weak, HD Supply has improved its operations, and we expect further
modest improvement in operations as the company maintains adequate liquidity.
We view HD Supply's business risk profile as satisfactory. The company has
leading market positions in its diverse lines of business and scale advantages
over its competitors, which continues to help it endure through a protracted
weak period in U.S. residential and nonresidential construction. Residential
and nonresidential construction markets now only account for about one-third
of the company's business, which constituted just greater than one-half of its
business several years ago. We believe that HD Supply's business is
stabilizing. The MRO and infrastructure markets now account for about
two-thirds of its business--these tend to be less cyclical than construction.
The construction markets appear to be gradually improving from their lows but
may remain relatively weak compared with prior spending.
Despite some end-market pressures, HD Supply has generated positive cash flow,
which we expect to continue, based on its business segments, geographic
diversity, industrial MRO business (which is less exposed to the housing and
commercial construction downturn), and its prior cost-cutting actions,
including branch closings and personnel reductions. The company has seen an
improvement in its industrial MRO business, which moves in tandem with
improved industrial demand. Over the longer term, we believe HD Supply's
leading business positions and scale of operations should provide competitive
advantages. HD Supply's business is not very capital expenditure-intensive.
We assess the company's financial risk profile as highly leveraged, initially
because of its leveraged buyout in 2007 and subsequently because of the weak
market conditions. However, some of the capital structure's features preserve
liquidity despite the operating downturn that occurred, and its liquidity is
well above the minimal liquidity requirements (before testing its financial
HD Supply recently refinanced its capital structure, and we view the extension
of maturities on its new debt as somewhat beneficial. Pro forma for the new
unsecured note offering it will have some remaining subordinated debt maturing
in 2015. The company had issued in April 2012 new payment-in-kind (PIK) senior
notes that are owned by the sponsors. We expect the company to have adequate
sources of liquidity to meet its cash outlays. We do not expect the company to
make any large acquisitions. Although the refinancing essentially leaves total
debt outstanding relatively unchanged, the capital structure will still have
almost $6 billion of funded debt.
We consider HD Supply's liquidity "adequate" to support the company's
operating needs. Our assessment of its liquidity currently meets or exceeds
our tests for adequate liquidity and incorporates our following expectations
-- We expect the company's sources of liquidity, including cash and
facility availability, to exceed its uses by 1.2x or more over the next 12 to
-- We expect net sources to remain positive, even if EBITDA declines more
-- We view HD Supply's relationships with banks as sound and believe that
it has a generally satisfactory standing in credit markets, given the recent
Liquidity sources currently include about $100 million in cash and about $1
billion of availability on its $1.5 billion asset-based loan (ABL) revolving
credit facility maturing in 2017. Although the borrowing-base advance limits
could decline, we do not expect to see any meaningful reductions in the
availability on the ABL--except when the company enters a seasonal buildup of
working capital. We expect HD Supply to continue to have availability on the
credit facility above the minimum liquidity requirement. The facility has a
springing fixed-charge covenant if availability under the borrowing base falls
to less than $150 million.
The company has no significant debt maturities now until 2015. Unsecured debt
includes about $800 million in senior notes due 2020 held by the sponsors and
pro forma about $1.1 billion in subordinated notes due in 2015 that are
currently cash-pay. Private equity sponsors and affiliates also hold a
substantial amount of the remaining subordinated notes.
For the full recovery analysis, please see the recovery report on HD Supply
Inc., to be published following this report on RatingsDirect.
The stable outlook reflects the modest but continual improvement in HD
Supply's operating performance and EBITDA. Although there is still a risk that
the currently weak end-market conditions will not improve measurably, we
believe that the company generates sufficient cash flow to service its
interest payments. Its current adequate liquidity supports the rating, and if
its EBITDA to cash interest coverage falls to less than 1x, the company has
access to cash and revolving credit availability to meet any shortfalls that
may occur in the near term.
Adequate liquidity and the lack of any sizable near-term debt maturities
offset significant uncertainty about operating profitability and cash flow
over the next year. However, if, for example, EBITDA to cash interest coverage
remains depressed, we see no prospects for improvement, and liquidity
diminishes, we could lower the ratings. We consider raising the ratings to be
unlikely at this time because of the relatively weak, albeit improving,
construction market conditions.
Related Criteria And Research
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18,
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Corporate Criteria: Analytical Methodology, April 15, 2008
HD Supply Inc.
Corporate Credit Rating B/Stable/--
Senior Secured Second Lien CCC+
Recovery Rating 6
Senior Secured First Lien B+
Recovery Rating 2
Senior Secured Revolver BB-
Recovery Rating 1
Senior Unsecured CCC+
Recovery Rating 6
Recovery Rating 6
HD Supply Inc.
$750 mil sr unsecd nts due 2020 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
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