-- U.S.-based commercial printing company R.R. Donnelley reported third
quarter results that were weaker than expected, with revenues down 6.5% and
-- We are affirming our 'BB' rating on the company.
-- We are revising our outlook to negative from stable. We are concerned
that the rate of revenue decline could accelerate, with repercussions for
discretionary cash flow, especially given our weak economic forecasts for 2013.
Nov 6 - Standard & Poor's Ratings Services today affirmed its 'BB'
corporate credit rating, as well as its other ratings, on Chicago-based R.R.
Donnelley & Sons Co. (RRD). At the same time, we revised the rating
outlook to negative from stable. The company reported weaker-than-expected
results for the third quarter (ended Sept 30, 2012), with revenues declining
6.5% in part because of steep declines for commercial printing and variable
printing services, which are economically sensitive. We see the risk that
revenues declines, which had been generally in the low single digits, could
accelerate, especially given the weak economic forecasts for 2013, with the
result that leverage will not decline to the upper-3x area (currently 4.3x as of
Sept 30, 2012), which is our target for the current 'BB' rating.
Our ratings on RRD are predicated on the company's positive cash flow
generation (despite revenue declines), and the assumption that leverage will
decline to the high 3x area by the end of 2013, provided that economic and
pricing pressures do not worsen. We regard the company's financial risk
profile as "significant" (based on our criteria). Our "fair" business risk
profile reflects RRD's market position and efficiencies associated with its
critical mass. The company faces secular declines in several of its products
and pricing pressure because of industry overcapacity. We believe that these
trends could cause RRD's organic revenue to decline over the near and
The printing industry has steadily lost ground to electronic distribution of
content and online advertising. As a result, it has been afflicted by
overcapacity, chronic pricing pressure, and the need to continuously take out
costs. RRD is the largest participant in the industry, with broad-based
services that address a variety of end markets. RRD's size confers important
efficiencies, the capacity to provide one-stop service to clients, the ability
to invest in leading technology, and the ability to cope with pricing pressure
more successfully than many of its competitors. Nevertheless, several of its
important end markets, notably the magazine, retail inserts, directory, and
book businesses, are subject to long-term adverse fundamentals as well as
general economic cyclicality. In the third quarter, its commercial printing
business and variable printing businesses, which are economically sensitive,
experienced significant declines. Industry volume shrinkage is likely to
continue to necessitate capacity downsizing and restructuring charges.
Our base-case scenario incorporates our expectation that revenue could decline
at a low-single-digit percent rate for 2012 and 2013. We believe EBITDA will
decline at a mid-single-digit percent rate in 2012 and could decline at a more
accelerated rate in 2013 because the company's ability to cut costs in line
with revenue decline is limited as a result of its high fixed costs. This
would cause EBITDA margin to decline to under 11%. We expect free cash flow of
about $450 million in 2012 and 2013 (even though 2013 will benefit from a
lower pension contribution).
In the third quarter, revenue declined 6.5% (5.2% on an organic basis).
EBITDA, which we calculate including restructuring charges, was flat,
partially because these charges were lower. The EBITDA margin widened to 11.3%
in the 12 months ended Sept. 30, 2012, from 10.6% in the same period last
year. RRD's leverage (adjusted primarily for pension and lease obligations and
including restructuring charges) was 4.3x for the 12 months ended Sept. 30,
2012. Leverage was above the adjusted debt-to-EBITDA range of between 3x and
4x that we associate with a "significant" financial risk profile. Management
reiterated in its Nov. 1 earnings call that it intends to maintain a leverage
target of 2.5x to 3.0x, according to its calculations, which excludes
restructuring charges and pension and lease adjustments. This corresponds to a
3.6x to 4.1x leverage figure based on our methodologies. The company also
stated that it intends to pay down debt this year and next year. We expect
leverage will be in the low-4x area at the end of 2012 and could decline to
the upper-3x area in 2013, assuming the company pays back some debt with free
cash flow. Further weakening of the economy, coupled with additional
restructuring charges by the company, could cause us to revise our leverage
assumptions. The company converted about 20% of EBITDA to discretionary cash
flow at Sept. 30, 2012. We expect the company to convert roughly 30% of EBITDA
to discretionary cash flow this year.
RRD has "adequate" liquidity, in our view, to cover its needs over the next 12
months, even with moderate unforeseen EBITDA declines. Our assessment of RRD's
liquidity profile incorporates the following expectations and assumptions:
-- We expect sources to cover uses by more than 1.2x for the upcoming 12
-- We believe sources minus uses would remain positive if EBITDA were to
drop by 15%.
-- Compliance with maintenance covenants would survive a 15% decline in
-- We believe the company could absorb high-impact, low-probability
impacts without refinancing.
We expect RRD to generate positive discretionary cash flow of roughly $450
million for the full year after annual capital expenditures of roughly $200
million to $225 million, and dividend payments of roughly $190 million. We
expect the company to generate about $300 million in discretionary cash flow
in 2013, benefiting from recent pension legislation that relaxes a pension's
sponsor's cash funding requirements, but offset by our expectation of lower
EBITDA. RRD does not have any significant near-term maturities. The company
had $767 million of availability under its new (Oct. 15) $1.15 billion
revolving credit facility ($344 million drawn). Covenants include a 3.75x
total leverage ratio and a 3.0x interest coverage covenant. In addition, the
company had $393 million of cash on its balance sheet as of Sept. 30, 2012.
For the latest recovery analysis, see Standard & Poor's recovery report on
Donnelley, to be published on RatingsDirect as soon as possible following the
release of this report.
The negative rating outlook reflects our concern that revenue declines could
accelerate from the historical 2.0%-2.5% rate, resulting in leverage remaining
above 4x (the high end of our threshold for the current rating).
We could lower the rating if we conclude that secular risks facing the company
have increased and could cause organic revenue to decline at a brisker pace or
that leverage will be chronically above 4x with little prospect for
improvement. This could occur if revenue were to decline at a mid-single-digit
percent rate and if the company's EBITDA margin were to decline.
We could revise the outlook to stable if we become convinced that leverage
will decline to below 4x on a sustainable basis. This could be achieved
through the company using its free cash flow to repay debt as we do not
anticipate a resumption of organic revenue and EBITDA growth in the next few
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
Rating Affirmed; Outlook Revised
R.R. Donnelley & Sons Co.
Corporate credit rating BB/Negative/-- BB/Stable/--
R.R. Donnelley & Sons Co.
Senior secured BBB-
Recovery rating 1
Senior unsecured BB
Recovery rating 4
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