OREANDA-NEWS. S&P Global Ratings affirmed all of its ratings on Calabasas, Calif.-based tool and equipment retailer Harbor Freight Tools USA Inc. (HFT), including the 'BB-' corporate credit rating. The outlook is stable.

At the same time, we assigned a 'BB-' issue-level rating to the proposed $2.2 billion senior secured term loan due 2023, which will repay the existing $1 billion term loan ($865 million outstanding as of April 30, 2016). The '3' recovery rating on the proposed facility indicates our expectation for meaningful recovery, at the lower end of the 50% to 70% range in the event of a payment default. As part of the refinancing, the company increased the unrated asset-based lending (ABL) revolving credit facility due 2021 to $700 million from $550 million, which will be partially drawn to fund the proposed dividend.

"The affirmation reflects our expectation that debt leverage will decline to under 4x over the next 12 months from EBITDA growth and debt repayment with cash flow generation. Pro forma for the proposed transaction, debt to EBITDA was 4.7x as of the third quarter ended April 30, 2016 (versus about 4.2x based on our assumptions for fiscal year 2016 ended July 31). The company's growth strategy has accelerated over the past three years--the store base increased to more than 680 stores from 445 stores in fiscal 2013," said credit analyst Samantha Stone. "We expect the company will continue to manage expenses and promotions while expanding into existing and new markets. Although same-store sales growth has declined because of cannibalization, the rating assumes same-store sales growth will remain positive as management refines its pricing and promotional strategies."

The stable rating outlook reflects our expectation that HFT's debt leverage will be under 4x over the next 12 months, based on revenue and profit growth from new store development and cost management. We believe the company will continue to manage leverage below 4x in order to retain sufficient prospects for access to capital markets to continue its practice of periodic large dividend payouts.

We would consider a negative rating action if debt leverage remains above 4x over the next 12 months after the proposed transaction closes. This scenario could be the result of weaker-than-anticipated operating performance, potentially caused by increased competition and poor execution or management missteps from store expansion that result in negative same-store sales, and a decline in gross margins and cash flow. Under this scenario, a decline in EBITDA margins by roughly 270 basis points would result in leverage of about 4.7x

A rating upside is highly unlikely over the next 12 months based on our assumptions for credit metrics and operating performance. Longer term, we could raise the rating on HFT if the company's financial policies moderate such that debt repayment would take a priority over dividends. At that point, we would consider the company's financial policy as neutral. Positive rating consideration would also include meaningful growth in scale and profitability in addition to maintain high operating margins as the company continues to expand.