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TEXT - S&P rates Northern Tool & Equipment Co
November 13, 2012 / 8:06 PM / 5 years ago

TEXT - S&P rates Northern Tool & Equipment Co

Overview
     -- U.S.-based Northern Tool & Equipment Co. Inc. is issuing a $200 
million seven-year term loan and a $100 million five-year asset-based 
revolving credit facility.  
     -- It plans to use the proceeds from the term loan and about $25 million 
under the revolver to finance the acquisition of Redcats Sports and Leisure 
Group, consisting of The Sportsman's Guide and The Golf Warehouse, from PPR 
S.A., for $215 million.  
     -- We are assigning our 'B+' corporate credit rating to Northern Tool and 
assigning our 'B+' issue-level rating to the company's proposed term loan.  
     -- The stable outlook reflects our view that modest profitability gains 
and debt reduction with excess cash flows will result in some improvement in 
credit protection measures in the next year.
 

Rating Action
On Nov. 13, 2012, Standard & Poor's Ratings Services assigned its 'B+' 
corporate credit rating to Minnesota-based Northern Tool & Equipment Co. Inc. 
We are also assigning a 'B+' corporate credit rating to Northern Tool & 
Equipment Catalog Co. Inc. The outlook is stable.

In addition, we are assigning a 'B+' (the same level as the corporate credit 
rating) issue-level rating to the company's proposed $200 million seven-year 
term loan.  The recovery rating is '3' indicating our expectation of 
meaningful (50% to 70%) recovery in the event of a payment default. We are not 
rating the revolver.
  

Rationale
The ratings reflect what we consider to be Northern Tool's "aggressive" 
financial risk profile, which incorporates substantial debt leverage following 
the proposed debt-funded acquisition, but good cash flow coverage ratios, and 
minimal near-term debt maturities that provides financial flexibility. In our 
view, its business risk profile is "weak," an assessment that factors in its 
small size in the highly competitive and fragmented home improvement and 
sporting goods retailing industries and its vulnerability to price 
competition.  

Pro forma for the transaction, leverage is nearly 4x and funds from operations 
(FFO) to debt is 18%, compared with 2.1x and 44% on July 31, 2012. In 
addition, EBITDA margins are about 7%, representing an increase from 6.3% 
previously, which results from the inclusion of the higher-margin Sportsman's 
Guide operations. Northern Tools indicated that its three businesses will 
operate on a stand-alone basis with the likelihood for cross-selling 
opportunities as they share a similar customer base, which is predominantly 
middle-aged males. We think the company should obtain modest cost savings in 
the near term, primarily from overhead consolidation. 

On a combined basis, operating performance has improved in the past year from 
better demand for tools and equipment, as well as product expansion in the 
outdoor sports and recreation segments. It also benefits from its fee-based 
membership program that we think provides a consistent stream of revenues and 
earnings. Still, the industry is highly competitive and entry barriers are 
low. Northern Tool competes against larger players such as Home Depot, Lowe's 
and on-line retailers such as Amazon. Its largest business division (about 65% 
of consolidated sales) sells tools and equipment, is influenced by trends in 
the housing market. Sales trends in this business are positive, and we expect 
this to continue in the near term given the existing home sales and consumer 
spending level for repair and remodeling activities.  

Although we expect only a modest economic recovery in the near term, we 
believe Northern Tool's profitability will increase as it benefits from its 
relatively niche position in the specialty retailing industry. Our projected 
performance during the next 12 months includes the following assumptions:
     -- Revenue growth of about 2% to 3%, as we anticipate about five to six 
new stores annually in the tools and equipment business and some benefits from 
the trends we are seeing in the housing market.  
     -- EBITDA margins advancing on sales leverage and some benefits from 
overhead costs savings.
     -- We adjusted operating cash flows for tax-related distributions. 
Northern Tool operates under subchapter S of the IRS tax code; as a result, it 
must pass a portion of its profits to shareholders who are in turn responsible 
for taxes on its profits.  
     -- Capital spending of about $15 million for new stores and systems 
upgrade.
     -- Modest debt reduction with excess cash flows. 
     -- No additional acquisitions in the near term.  

Considering these assumptions, we anticipate leverage declining to about 3.5x 
by year-end 2013 and FFO to debt increasing to about 20%. In addition, we 
expect interest coverage to improve slightly, to nearly 4x. Although we do not 
anticipate material shareholder initiatives in the near term, we view the 
company's financial policies to be influenced by its private ownership as a 
risk factor. In our opinion, these attributes support our assessment of the 
company's financial risk profile as aggressive.
 
Liquidity
We believe Northern Tool will have adequate liquidity in the next 12 months. 
Liquidity sources include cash balances between $30 million to $35 million, 
generated cash flows, and a $100 million asset-based revolving credit 
facility.  Relevant aspects of our liquidity analysis include the following:
     -- Sources will exceed uses by 1.2x or more in the next 12 months.
     -- Sources will be positive, even if we forecast a 15% decline in EBITDA. 
 
     -- We expect the company to generate about $25 million to $30 million in 
excess cash flows after about $15 million capital spending and approximately 
$20 million in dividends.  
     -- We estimate about $75 million availability under the revolver at 
inception of the transaction.
     -- No significant debt maturities in the next one to two years.  

The revolving credit facility will have a minimum fixed charge coverage of 
1.1x and a cash dominion requirement, both subject to borrowing base 
availability. We do not anticipate covenant compliance issues considering our 
cash flow assumption.

Recovery analysis
The issue-level rating on the company's proposed $200 million seven-year term 
loan is 'B+' (the same level as the corporate credit rating). The recovery 
rating is '3' indicating our expectation of meaningful (50% to 70%) recovery 
in the event of a payment default. For the complete recovery report, please 
see the report to be published on RatingsDirect following release of this 
article.


Outlook
The stable outlook reflects our view that Northern Tool will benefit from 
modest sales and profit growth in the next year. We think the company will 
generate cash flow to fund its core requirements and tax-related 
distributions, and will use excess cash flows to partly reduce debt. 
Specifically, we anticipate leverage declining to the mid-3x area and FFO to 
debt increasing to about 20%.  

We could consider a higher rating if Northern Tool's business fundamentals 
improve above our expectations, for example, higher demand for tools and 
equipment and expansion of its private label offerings, or if it can leverage 
its common customer base across all three businesses to garner meaningful 
sales growth. If these trends were to occur, we could see EBITDA margins 
expanding to the mid-8% area and leverage declining to about 3x. We would also 
need to see FFO improving to about 25% and be comfortable that financial 
policy decisions will not impair credit protection measures.  

Alternatively, we could consider a downgrade if increasing competition in its 
core businesses hurts Northern Tool's operating performance, or if 
merchandising issues lead to significant inventory markdowns. Under such 
scenario, we could see a 200-basis-point contraction of EBITDA margin and an 
increase in leverage to nearly 5x.  Additional factors that could trigger a 
downgrade include large debt-funded dividends or acquisitions.  

Related Criteria And Research
     -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 
     -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 
     -- 2008 Criteria Methodology, April 15, 2008


Temporary telephone contact numbers: Andy Sookram (917-992-6642); Kristina 
Koltunicki (646-276-0214)

Ratings List

New Rating; Outlook Action

Northern Tool & Equipment Company Inc.
Northern Tool & Equipment Catalog Company Inc.
 Corporate Credit Rating                B+/Stable/--       


Northern Tool & Equipment Catalog Company Inc.
Northern Tool & Equipment Company Inc.
 Senior Secured
  US$200 mil  term loan bank ln due     B+                 
  2019                                  
   Recovery Rating                      3

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