Overview -- Buffalo, N.Y.-based grocery store operator Tops Holding Corp. is issuing $460 million of senior secured notes. The proceeds plus funds drawn on a new asset-based revolving credit facility will be used to refinance the company's existing notes, fund a dividend to equity holders, and pay fees associated with the transaction. -- The increased debt means the company's credit ratios will weaken but Standard & Poor's expects moderate improvement in the next year. -- As a result, we are revising our outlook on Tops to negative from stable and affirming our 'B+' long-term corporate credit rating on the company. -- We are also assigning our 'B+' issue-level rating and '4' recovery rating to the company's proposed note issuance. -- The negative outlook reflects credit ratios that are somewhat weak for the rating, and that possibility that economic and industry conditions could strain operating performance and credit metric improvement. Rating Action On Dec. 6, 2012, Standard & Poor's Ratings Services revised its outlook to negative from stable on Buffalo, N.Y.-based Tops Holdings Corp. At the same time, Standard & Poor's affirmed its 'B+' long-term corporate credit rating on the company. The outlook revision is based on the company increased debt and weakened credit ratios following a dividend payment to its equity sponsor, and also reflects the possibility that operating performance could be moderately weaker than we expect. Therefore, Tops will not enhance its credit protection measures as expected, and we could consider lowering the rating within the next year. At the same time, Standard & Poor's assigned its 'B+' issue-level rating and a '4' recovery rating to the company's proposed $460 million senior secured note offering. We rate the notes the same as the corporate credit rating; the '4' recovery rating indicates our expectation of average (30%-50%) recovery in the event of default. Rationale The ratings on Tops reflect our view of the company's financial risk profile as "highly leveraged", which we revised from "aggressive" following this transaction. We base this revision on our forecast of credit ratios, which incorporate the increased debt, moderate profit growth, and some improvement in credit ratios in the next year. We assess Tops' business risk profile as "weak," which reflects its geographic concentration and participation in the very competitive food retail industry. This combination of risk factors would generally indicate a lower corporate credit rating. The difference reflects our view that the company is on the cusp for financial risk, as it would take only a moderate improvement for credit ratios to again be indicative of an "aggressive" financial risk profile. The supermarket industry is experiencing continued incursions from discounters, dollar stores, warehouse clubs, and drug stores. Nevertheless, we believe this competition is tempered in Tops' markets relative to the rest of the country, and that the company is reasonably well-positioned to maintain its current market share. As a result of the transaction, debt increases by approximately $130 million, and on a pro-forma basis debt to EBITDA (adjusted to for operating leases, company-sponsored pension plans, and multi-employer pension plans) increases to about 5.6x from approximately 4.8x at the end of the third quarter. The pro forma ratio also includes expected sales and profits from the recently acquired Grand Union stores. The company's third-quarter operating results were in line with our expectations and commensurate with many industry peers. Generally, in the near future we expect steady performance at the company's existing store base since the local economy is stable, there is limited competition from conventional grocers, and only inconsequential new entrants into the company's primary markets. In fact, we believe Tops is well-positioned to take market share from the small amount of independent operators in upstate New York, either through minor store acquisitions or better promotional and merchandising strategies, which could drive greater-than-expected profit growth. Nevertheless, unemployment has remained elevated, economic growth has been limited, and fuel prices remain a constant threat to disposable incomes. These factors could strain consumer spending at the grocery stores, leading to weaker operating performance at Tops and represent the biggest risk to our baseline performance expectations. This is outlined below for 2013 relative to current last 12 month levels: -- Relatively flat comparable-store sales, and revenue growth to be about 8%. About half of the growth is from the acquired Grand Union stores and the remainder is from an increased number of fuel stations and higher fuel volumes. -- Slight contraction of operating margins of about 10-20 basis points, driven mostly by the higher fuel volumes. -- EBTIDA growth in the 4%-6% range and EBITDA to be near $160 million for 2013. -- We also expect the company to repay its revolver borrowings within the next year. This performance scenario would lead to the following adjusted credit ratios at the end of 2013: -- Debt to EBITDA in the range of 5.2x-5.3x; -- EBITDA interest coverage of about 2.5x; and -- Funds from operations (FFO) to debt of approximately 11%. These credit ratios are in line with indicative ratios of a highly leveraged financial risk profile, but with only moderate improvement these ratios would be in line with those for an "aggressive" financial risk assessment. In calculating credit ratios, we adjust debt and EBITDA for multiemployer pension plan obligations and contributions. Our debt adjustment includes our estimate of the company's share of the underfunded portion of the plans in which it participates. To calculate the underfunded portion, we use the Retirement Protection Act of 1994 (RPA '94) liability less the fair value of assets on the same date. In this case, we then haircut the underfunded status by 30% for further benefit reductions, and then tax-effect the remaining portion. To calculate the company's portion, we look at the company's contribution relative to entire contributions by plan participants. Tops participates in only one plan, and the most recent date for which we have information on the plan is Dec. 31, 2011. Our current debt adjustment is $157 million. We adjust EBITDA to reflect only the present value of future benefits employees earned for services rendered in the period, which we estimate to be approximately half of the annual contributions to the plan and currently $4.5 million. We view Tops' business risk as weak, reflecting the company's geographic concentration in the highly competitive food retail industry. Tops' performance has been relatively stable in the past few years and has outperformed some traditional food retailers, which have experienced sales and profit declines as a result of price competition and a weak economy. We attribute Tops' performance to the company's limited competition from traditional grocers and its relatively effective promotional and merchandising strategies. Nevertheless, larger competitors such as "here &sid=1031051&sind=A&" (BBB+/Stable/--) and Wal-Mart Stores Inc. (AA/Stable/A-1+) have significant presence in Tops' markets, and we believe aggressive pricing strategies by those competitors could hurt the company's operating performance in the future. Liquidity We view Tops' liquidity as "adequate" and we expect sources of liquidity to be greater than uses in the next 12 months by a ratio of at least 1.2x. After the transaction, we expect sources of liquidity to include available borrowings on its new $125 million revolving credit facility, and FFO, which we expect in 2013 to be between $90 million and $100 million. We do expect the company to have meaningful excess cash after the transaction. We expect uses to include minor working-capital investments and capital spending in the range of $40 million-$50 million. We also expect the company to generate about $50 million in discretionary cash flow in 2013. Relevant aspects of Tops' liquidity, in our view, are as follows: -- Coverage of uses by sources to be in excess of 1.2x for the next two years; -- Sources to exceed uses, even with a 15% drop in EBITDA; -- No meaningful maintenance financial covenants; -- No near-term maturities after the transaction; and -- Solid relationships with its banks. Recovery analysis For the full recovery analysis, please see the recovery report on Tops, to be published on RatingsDirect on the Global Credit Portal, following this report. Outlook The negative outlook reflects what we view as pro forma credit ratios that are relatively weak for the current rating, and the chance that Tops will not improve its credit ratios as expected because of weak economic conditions. If we were to modify our forecast of adjusted debt to EBTIDA such that it was at or above 5.4x, we would consider lowering the rating. This could occur if we believed unadjusted EBITDA would be $152 million or lower in 2013, about 5% below our forecast, which could be driven by an additional 20-30 basis points of margin contraction. On the other hand, if the company can meet our expectations in the next year and we were comfortable that it could sustain modest profit growth and leverage near 5x, we could revise our outlook to stable. Related Criteria And Research -- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Methodology and Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Criteria Guidelines For Recovery Ratings On Global Industrials Issuers' Speculative-Grade Debt, Aug. 10, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008 -- Standard & Poor's Approach To Analyzing Employers' Participation In U.S. Multi-Employer Pension Plans, May 30, 2006 Temporary contact number: Charles Pinson-Rose (917-280-6289) Ratings List Outlook Revised To Negative To From Tops Holding Corp. Tops Markets LLC Corporate Credit Rating B+/Negative/-- B+/Stable/-- Rating Assigned Tops Markets LLC Senior Secured US$460 mil sr secd nts due 2017 B+ Recovery Rating 4 Ratings Affirmed/Recovery Rating Unchanged Tops Holding Corp. Senior Secured Local Currency B+ Recovery Rating 3 Tops Markets LLC Senior Secured Local Currency B+ Recovery Rating 3 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.