Fitch assigns negative rating outlook to Rite Aid's US$481M of guaranteed senior unsecured notes due 2020, citing drugstore chain's high leverage, limited capital, operating statistics that significantly trail its two major competitors
February 15, 2012
– Fitch Ratings has assigned a rating of 'CCC/RR5' to Rite Aid Corporation's (Rite Aid) $481 million of guaranteed senior unsecured notes due 2020. The proceeds will be used to redeem the $460 million 9 3/8% guaranteed senior unsecured notes due 2015. The Rating Outlook is Negative. A full rating list is shown below.
The ratings reflect the following:
--Rite Aid's high leverage, limited capital for investment and operating statistics that significantly trail its two major competitors;
--Strong market share position as the third largest U.S. drug retailer;
--Management's concerted efforts to improve the productivity of its store base and manage liquidity through refinancing activity over the last two years, working capital reductions and other cost cutting initiatives.
Fitch expects that credit metrics will remain stable at current levels over the next three years. The Negative Outlook incorporates refinancing risk. In the next couple of years Rite Aid will have to address a series of significant debt maturities that will occur between 2014 and 2016, in an aggregate amount of $2.5 billion post this refinancing. To the extent that Rite Aid successfully addresses upcoming debt maturities and sustains stable to positive same store sales and EBITDA trends, Fitch would resolve the Negative Outlook.
There have been some recent signs of stabilization in EBITDA with same store sales turning modestly positive and over the next 12-24 months, the generic wave could provide a nice windfall to the company's profitability. The current impasse between Walgreen and Express Scripts could also provide some boost to prescription volume. Whether this pushes EBITDA into the $1 billion plus range remains to be determined given offsetting factors such as continued share losses to larger and more capitalized competitors, ongoing pressure on pharmacy reimbursement rates and weak consumer sentiment. The company is also highly dependent on favorable credit market conditions to get this magnitude of refinancings completed given modest FCF generation.
At Nov. 26, 2011, Rite Aid had cash of $148 million and excess borrowing capacity of approximately $850 million under its credit facility. The company has maintained liquidity in the $850 million to $1.2 billion range for the past eight quarters.
For the latest 12-month period ended Nov. 26, 2011, total same store sales was positive at 1.5% with a front end same store sales increase of 0.9% and a pharmacy same store sales increase of 1.7%. Adjusted EBITDA (adjusted for non-cash and one time items) increasing modestly by $36 million to $884 million and adjusted debt/EBITDAR at 7.6 times (x) and EBITDAR/interest + rent at 1.2x were largely flat to fiscal year end levels given modest debt reduction. Credit metrics over the next three years are expected to remain relatively stable. Fitch expects modest same store sales growth of 1% and mid-to-high single digit growth in EBITDA in 2012 and 2013 driven largely by the introduction of higher margined generics and somewhat offset by continued pharmacy reimbursement pressures.
Risks to estimates are a decline in same store sales trends due to macro weakness or share losses to its larger peers and higher than expected decline in reimbursement rates. Rite Aid's operating metrics significantly lag those of its largest and well capitalized competitors, CVS Caremark and Walgreen. Rite Aid has been unable to participate in the strong industry growth largely due to capital constraints and the company's inability to appropriately invest in its stores remains an ongoing concern. Beyond the benefit from the generic wave in 2012-14, Fitch does not expect meaningful top line and EBITDA expansion over the next few couple years given the lack of capital to execute successfully on its plans to address underperforming stores. As a result, EBITDA margins are likely to remain depressed, which at 3.5% (excluding non-cash and merger related expenses) for the LTM period is significantly below its two leading competitors' margins (with Walgreen's EBITDA margin at 7% and CVS retail EBITDA margin at 9.9%).
The issue ratings on the new guaranteed senior unsecured notes are derived from the Issuer Default Rating (IDR) and the relevant Recovery Rating. Fitch's recovery analysis assumes a liquidation value under a distressed scenario of approximately $6 billion on inventory, receivables, owned real estate and prescription files. Given the amount of secured debt in the company's capital structure, the unsecured guaranteed notes are assumed to have below average recovery prospects (11%-30%) and are thus rated 'CCC/RR5'.
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