October 3, 2017 / 11:49 AM / 10 months ago

Fitch Rates Afflelou's Planned EUR425m Notes 'B+(EXP)'

(The following statement was released by the rating agency) FRANKFURT/LONDON, October 03 (Fitch) Fitch Ratings has assigned 3AB Optique Developpement's S.A.S. (3AB) planned EUR425 million senior secured notes due 2023 an expected senior secured rating of 'B+(EXP)' with a Recovery Rating of 'RR3'. 3AB is a financing vehicle of French-based healthcare group Lion/Seneca France 2 S.A.S's (Afflelou). Proceeds from the notes will be used to redeem EUR365 million 5.625% senior secured notes issued by 3AB and EUR75 million 7.875% senior notes issued by Afflelou, both due in 2019. The planned notes will be guaranteed on a senior secured basis by Afflelou's entities representing at least 80% of consolidated EBITDA or gross assets, and will rank equally with all existing and future secured indebtedness that is not subordinated to the notes. However, the notes will rank behind Afflelou's super senior revolving credit facility (RCF) and certain hedging facilities in the event of enforcement. The refinancing will marginally enhance Afflelou's financial profile by reducing funds from operations (FFO) adjusted gross leverage by 0.3x, and improve the company's financial flexibility by reducing annual debt service to around EUR21 million from EUR27million and extending the maturity profile. The final rating of the notes is contingent upon receipt of final documents conforming to the information already received by Fitch and confirmation of the final amount and tenor of the notes. Upon completion of this transaction, Fitch expects to affirm Afflelou's IDR at 'B' with a Stable Outlook. Fitch also expects to withdraw the EUR 365 million senior secured notes' rating of 'BB-' issued by 3AB and the EUR 75 million senior notes rating of ''CCC+' issued by Afflelou upon repayment of the notes. KEY RATING DRIVERS Lower Recoveries for Senior Secured Creditors: We project the new senior secured notes will see lower recoveries equivalent to 'RR3' compared with 'RR2' in the current structure primarily given a higher expected quantum of senior secured debt post refinancing relative to the existing debt structure. Transaction Improves Financial Profile: The planned refinancing will lead to a reduction in gross debt to EUR425 million (excluding RCF of EUR30 million, which is expected to remain unchanged) from EUR440 million and will provide increased leverage and financial flexibility headroom at the current ratings. We expect to see some deleveraging as a result of continued growth in profits and project that FFO adjusted gross leverage will reduce to 6.2x for the financial year to July 2018 (from 6.7x at FYE17) following a successful completion and fall towards 6.0x thereafter. The new capital structure should result in lower interest costs leading to improved coverage metrics with FFO fixed charge coverage trending towards 2.4x by FY20 from 1.9x at FY17. Stable Operating Performance: Afflelou's healthy results continued in FY17, with network sales, group revenue and EBITDA all exceeding our previous expectations. This was driven by growth in all regions, with strong like-for-like (lfl) increase in France. Cooperation with major care networks is continuing to bear fruit, which is reflected in higher network activity and increased earnings. Such operating developments reflect a successful implementation of Afflelou's business strategy and adaptation of the company to an evolving trading environment. Strong Cash Flow Generation: Fitch projects Afflelou will generate consistently positive free cash flows (FCF) with mid-to-high single-digit FCF margins. Moreover, Afflelou's cash conversion as measured by FCF/EBITDA (as defined by Fitch) is fairly strong relative to the medians for European leveraged retail peers in the 'B' rating category. This assumption is supported by steadily expanding EBITDA, which is driven by higher network activity, coupled with lower cash interest expenses following the refinancing. In addition, Afflelou's efforts to reduce the number of directly-owned stores through sale or closure should improve cash flows and credit metrics, underpinning the asset-light nature of Afflelou's business model as a franchisor model. Small-scale acquisitions are embedded in the current ratings, and they can be comfortably funded by internal cash. DOS Reduction Viewed Positively: Management's efforts to reduce the group's portfolio of directly owned stores (DOS) in the medium term could provide some upside to the current ratings if successfully implemented as it would result in lower rental expenses and capital expenditure and have an immediate positive impact on EBITDA, FCF generation and adjusted credit metrics. We do not include a material reduction in DOS in our current rating case given the execution risks associated with disposing the shops as well as the group's recent track record of trying to reduce the estate. However, should management successfully implement this plan, it would be positive for the ratings. DERIVATION SUMMARY Afflelou's Long-Term IDR of 'B'/Stable reflects a symbiotic business model with healthcare and retail components. The business benefits from a favourable reimbursement policy for eye-care in France. This provides for greater operational stability compared with conventional retailers, who face less predictable consumer behaviour, and as a result, are exposed to higher sales and earnings uncertainties. Consequently, Afflelou's operational resilience tolerates slightly higher financial risk compared with pure retail peers such as Mobilux 2 SAS (B/Stable), New Look Retail Group Ltd (CCC) and Financiere IKKS S.A.S. (CCC). Compared with healthcare peers Synlab Unsecured Bondco PLC (B/Stable) and Cerberus Nightingale 1 S.A., Afflelou is rated at the same level despite a slightly lower leverage, as its business model contains higher risk due to its retail element. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Revenue growth of 3% in FY18 decelerating gradually thereafter, marking the ongoing transition to closer cooperation with care networks; - Adjusted EBITDA margin improving towards 21.4% by FY20 from 20.6% in FY17; - Trade working capital outflow of EUR6 million per annum; - One-off payment of EUR6 million to management included in FY18; - Capex remaining stable at EUR11 million per annum; - Small bolt-on acquisitions annually offset by some asset or store disposals; RECOVERY ASSUMPTIONS We use the going-concern approach in our recovery analysis given Afflelou's asset-light business model. We have increased the EBITDA discount to 20% from previously 15% to reflect improved operating performance and lower post-operating costs (debt service and maintenance capex) and applied it to FY17 adjusted EBITDA of EUR77 million, resulting in a post restructuring EBITDA of around EUR60 million. At this level of EBITDA Afflelou's annual cash flow generation would be negative, while the capital structure with 8.0x on FFO adjusted basis would move closer to being unsustainable. We assume that the company will retain access to capital leases, the cost of which is estimated at EUR0.25 million, which we have deducted from the distressed EBITDA and consequently excluded from the creditor mass. Using a distressed enterprise value (EV)/EBITDA multiple of 5.5x we arrive at the post-restructuring EV of EUR336 million. After distributing 10% of this value for administrative claims, the new super senior RCF, which we assume will be fully drawn in a distress scenario, is estimated to recover up to 90%. We estimate senior secured note holders will recover 64% (RR3), implying a one notch uplift above the IDR, or 'B+'/RR3. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action -Consistently improving EBITDA as a result of increased network activity and no negative impact from regulatory changes; -FCF margin of at least 5% on a sustained basis; -FFO gross adjusted leverage moving sustainably towards 5.5x; and -FFO fixed charge cover improving towards 2.5x. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action -Deterioration of EBITDA and FCF margins as a result of continued weak network activity, impact of regulatory changes, adverse supplier mix changes or further material increase of the DOS segment; -FFO adjusted gross leverage above 7.0x with no evidence of deleveraging, for example because of operating underperformance or ongoing acquisition activity; -Unsuccessful integration of new acquisitions; and -FFO fixed charge cover of 1.8x or below. LIQUIDITY Comfortable Liquidity Position: Fitch projects Afflelou will generate comfortable FCF of about EUR26 million in FY18 followed by about EUR40 million per year thereafter, supported by strong network performance and the impact of the national care networks. This strong internal liquidity should comfortably accommodate small scale business additions. It also has a new committed RCF of EUR30 million available until April 2023, which we project will remain undrawn until maturity. Contact: Principal Analyst Patrick Durcan Analyst +44 20 3530 1298 Elena Stock Director +49 69 768076 135 Fitch Deutschland GmbH Neue Mainzer Strasse 46-50 D-60311 Frankfurt am Main Germany Committee Chairperson Pablo Mazzini Senior Director +44 20 7530 1021 Media Relations: Francoise Alos, Paris, Tel: +33 1 44 29 91 22, Email: francoise.alos@fitchratings.com; Adrian Simpson, London, Tel: +44 203 530 1010, Email: adrian.simpson@fitchratings.com. Summary of Financial Statement Adjustments - - Leases capitalised by 8.0x for adjusted leverage metrics Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. Applicable Criteria Corporate Rating Criteria (pub. 07 Aug 2017) here Country-Specific Treatment of Recovery Ratings (pub. 18 Oct 2016) here Non-Financial Corporates Notching and Recovery Ratings Criteria (pub. 16 Jun 2017) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. 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