Standard & Poor's assigns B corporate credit rating to 99 Cents Only Stores, with stable outlook
February 20, 2012
(Standard & Poor's)
– -- Ares Management LLC and Canada Pension Plan Investment Board has acquired Commerce, Calif.-based discount retailer 99 Cents Only Stores for about $1.6 billion.
-- After receiving final documents and reviewing the terms, we are assigning our 'B' corporate credit rating to the company.
-- We are assigning a 'B+' issue-level rating with a '2' recovery rating to the company's proposed $525 million term loan. We are also assigning a 'CCC+' issue-level rating with a '6' recovery rating to the proposed $250 million senior unsecured notes.
-- The stable outlook reflects our belief that credit metrics will not vary significantly from pro forma levels, though we do anticipate some improvement based on EBITDA gains and some debt pay down.
Feb 17 - Standard & Poor's Ratings Services assigned a 'B' corporate credit rating to 99 Cents Only Stores. The outlook is stable.
At the same time, we assigned a 'B+' issue-level rating with a '2' recovery rating to the company's $525 million term loan. The '2' recovery rating indicates our expectation for substantial (70% to 90%) recovery of principal in the event of a payment default.
We also assigned a 'CCC+' issue-level rating with a '6' recovery rating to the company's $250 million senior notes. The '6' recovery rating indicates our expectation for negligible (0% to 10%) recovery of principal in the event of a payment default.
Ares and Canada Pension Plan Investment Board (CPPIB) used the company's unrated asset-based lending facilities, together with $224 million in cash and equivalents and $636 million in equity, to buy 99 Cents for about $1.6 billion, excluding fees and expenses. Our ratings on 99 Cents reflect our expectation that the company's pro forma metrics will remain indicative of a "highly leveraged" financial risk profile (based on our criteria).
99 Cents is taking on a relatively large debt load and reduced cash position following the deal, with pro forma leverage of 5.7x on Nov. 30, 2011 and about $12 million in cash, reflecting a very aggressive financial policy. This is a significant change after a long history of a conservative financial policy that involved minimal debt and large cash holdings--of about $200 million in recent years. The debt-financed deal also results in significantly weaker free operating cash flow (FOCF) generation for the company. Pro forma EBITDA coverage of interest is likely to be only 2.4x for fiscal 2012, compared with 12.9x in the past quarter.
We expect operational improvement, coupled with modest debt reduction as mandated by the 50% cash flow sweep, to result in moderate improvement of these metrics over the intermediate term. Although the proposed credit facilities will limit dividends, we believe that dividend payments are likely in the future, given the private ownership of the company by Ares and CPPIB.
We view 99 Cents' business profile as "vulnerable," reflecting its West Coast focus and position as a smaller player in the highly competitive dollar store sector, compared with major competitors that include Dollar General Corp. and Family Dollar Stores Inc.
The company has demonstrated strong sales growth during the past several years and we expect that its strategy of focusing on more closeout merchandise at lower prices will continue to propel profitability over the near term. We expect the EBITDA margin will continue to increase from its current 11.2% level, as the company continues to benefit from operational efficiencies and store growth, which will help offset inflationary pressures.
In our view, the company's profitability depends on its ability to expand within its Texas, Arizona, California, and Nevada markets in the near term, while maintaining mid-single-digit comparable-store sales in its existing stores. Historically, the company has expanded at between 10 to 20 stores annually and we expect tis trend to continue in the intermediate term. We
believe the company's unique fresh grocery offerings, large stores, and effective cost-cutting initiatives will continue to bolster sales and profitability improvement over the near term.
We view 99 Cents' liquidity as "adequate," as we expect its sources of liquidity to be greater than its uses over the next 12 to 18 months. Our assessment of the company's liquidity profile includes the following factors and assumptions:
-- We expect coverage of uses by sources in excess of 1.2x or more for the next 12 to 18 months.
-- We expect the net sources to be positive, even with a 15% to 30% EBITDA decline.
-- The company will have to comply with its fixed-charge coverage ratio if excess availability under its ABL revolving facility is less than $10 million or 12.5% of the lesser of the ABL facility amount or the borrowing base.
-- No near-term debt maturities.
We do not rate the company's $175 million asset-based loan (ABL) revolving credit facility, which recently had about $10 million drawn.
For the complete recovery analysis, see the recovery report on 99 Cents, to be published as soon as possible following this report on RatingsDirect.
The outlook is stable. Pro forma credit metrics are in line with the rating category, and we expect that operational improvement, coupled with modest debt reduction, will result in improved credit measures over the intermediate term. We expect revenue growth in the mid-single digits due to positive same-store sales growth and the opening of new stores. We expect improving EBITDA margins as benefits from inventory management, labor reduction, and improved distribution helps offset inflationary pressures.
We could raise the rating if successful store expansion and pricing strategies generate double-digit same-store sales and gross margins improve 60 basis points. This would result in leverage below 5.0x. We could lower the rating if competitive pressures, coupled with operational inefficiencies, result in meaningful loss of market share, leading to weaker profitability and leverage above 6.0x. This could occur, for example, if sales remain flat and gross margin narrows about 60 basis points.
Related Criteria And Research
-- Use Of CreditWatch And Outlooks, Sept. 14, 2009
-- Business Risk/Financial Risk Matrix Expanded, May 27, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
New Rating; Outlook Action
99 Cents Only Stores
Corporate Credit Rating B/Stable/--
US$525 mil term loan bank ln due 2018 B+
Recovery Rating 2
US$250 mil sr nts due 2020 CCC+
Recovery Rating 6