-- U.S.-based bagel bakery restaurant chain Einstein Noah Restaurant
Group Inc. amended its existing capital structure and paid
approximately $68 million in special dividends to its shareholders.
-- Moderately lower debt balances than the company initially planned
during its October 2012 dividend recapitalization led to meaningful
improvement of credit metrics and our reassessment of the company's financial
-- We are raising our corporate credit rating to 'B+' from 'B'.
-- The stable outlook reflects our view that favorable trends in the
bakery-cafe segment, menu innovations, and cost savings initiatives will
propel modest profitability gains over the next year.
On Jan. 16, 2013, Standard & Poor's Ratings Services raised its corporate
credit rating on Lakewood, Co.-based Einstein Noah Restaurant Group Inc. to
'B+' from 'B'. The rating outlook is stable.
The upgrade reflects our reassessment of the company's financial risk profile
as "aggressive" because of the enhanced credit protection profile. The rating
on Einstein Noah also takes into account our assessment of its business risk
profile as "vulnerable". We believe that these assessments will not change
over the next year.
The "aggressive" financial risk profile assessment reflects Einstein's
moderately improved credit metrics resulting from lower debt balances. In
October 2012, Einstein planned to issue a $265 million credit facility to
refinance its existing debt and pay a one-time special dividend to its
shareholders. However, the proposed transaction did not close and the company
instead amended its existing Dec. 20, 2010, credit agreement. The amendment
increased the company's term loan to $100 million from $75 million and its
revolver to $75 million from $50 million. The company used proceeds from the
incremental term loan, along with about $40 million borrowings under the
revolver, to pay approximately $68 million in dividends to its shareholders.
Einstein's credit measures are moderately stronger following the amendment of
the credit facility, than initially contemplated in the October 2012
transaction. Pro forma total debt to EBITDA as of Oct. 2, 2012, is now about
3.9x compared with 5.6x. EBITDA coverage of interest improved to the mid-3x
area from about 2.5x, and funds from operations (FFO) to total debt ratio is
now slightly over 20% versus an initial estimate of 14%. We anticipate modest
improvement of these measures mainly from small EBITDA gains and modest debt
reduction over the next 12 months. We anticipate that debt leverage will
improve to about 3.7x, coverage of interest will strengthen to nearly 4x, and
FFO to total debt will improve to about 26% at fiscal 2013 year-end.
The "vulnerable" business risk profile reflects Einstein's small position in
the increasingly competitive and highly fragmented bakery-cafe segment of the
restaurant industry, its strong dependence on the breakfast segment, and
limited product diversity. We believe that the large concentration of sales
during breakfast hours will expose the company to significant competition as a
growing number of restaurant chains add or expand their breakfast offerings.
In addition, insignificant start-up costs associated with similar food service
establishments make it easy for new competitors to enter the market.
Recent operating trends have been positive, aided by the introduction of
healthy menu options, an expanded selection of specialty coffees and other
beverages, and a reinvigorated catering business. The company's initiatives to
propel growth in its lunch daypart have yet to gain traction. Given its
limited success so far in this endeavor and growing competition from much
larger Panera Bread, we do not expect the company to significantly change its
sales mix in the next one to two years.
Same-store sales increased modestly for the past five quarters and EBITDA
margins widened to about 14.7% as of Oct. 2, 2012, from about 12.9% one year
ago. The company continues to benefit from supply chain-related cost
initiatives, closed commissaries, and positive sales leverage. We expect
EBITDA margins to remain relatively stable during 2013, despite likely
commodity inflation, reflecting benefits from operating initiatives and growth
in the franchise and license agreement sectors.
Although we expect persistently high unemployment and only modest economic
recovery into 2013, we believe Einstein will post modest profitability growth
as it benefits from its position in the fastest-growing segment of the
restaurant industry. Our projected performance for Einstein during next 12
months includes the following assumptions:
-- Revenue growth in the low-single-digit percentage primarily as a
result of modestly positive same-store-sales coupled with growth of franchised
and licensed units.
-- Relatively stable EBITDA margins around the current level of 14.7% as
benefits of sales leverage and cost initiatives offset commodity inflation.
-- Capital spending of slightly more than $20 million to support store
remodels and expansion.
-- Modestly higher free operating cash flows of about $19 million in 2013
resulting from lower debt balances and lower interest expense.
-- Dividend payments of about $9 million per year.
We view the company's liquidity as "adequate". Pro forma for the amendment of
the company's credit facility, Einstein's sources of liquidity consist of $12
million of cash on Oct. 2, 2012, FFO of over $30 million, and about $35
million available under the $75 million revolving credit facility. We
anticipate that the company will continue to generate modest free operating
cash flow. Other 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.
-- No near-term debt maturities as the amended credit facility now
matures in December 2017.
-- We anticipate the company to have at least a 20% cushion in the
proposed financial covenants.
-- The company appears to have sound relationship with its banks.
Our stable outlook reflects our view that Einstein's performance will benefit
from favorable trends in the bakery-cafe segment of the restaurant industry,
despite heightened competition. We expect the company's menu innovations
coupled with cost savings initiatives to propel modest profitability gains
over the next year.
We could raise the rating on Einstein if we reassessed its business risk
profile to "weak" from the current "vulnerable," while the company at least
maintains its existing credit metrics. However, we consider an upgrade
unlikely over the next 12 months, given Einstein's small position in the
increasingly competitive breakfast segment of the restaurant industry, and its
lack of success in increasing its lunch business.
Alternatively, we could consider a downgrade if increasing competition in the
breakfast daypart hurts Einstein's sales growth and margins and results in
leverage that exceeds 4.5x. This could happen if revenues remain flat in 2013
and commodity inflation hurts gross margin by about 200 basis points from the
Oct. 2, 2012, level. Given the company's vulnerable business risk profile,
another debt-financed dividend that results in leverage increasing over the
indicated threshold could also trigger a downgrade.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Use Of CreditWatch And Outlooks, Sept. 14, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
Temporary contact number: Mariola Borysiak (973-518-0389)
Einstein Noah Restaurant Group, Inc.
Corporate Credit Rating B+/Stable/-- B/Stable/--