S&P: At Home Holding III Inc. Rating Raised To 'B', Subsequently Withdrawn; New Parent At Home Group Inc. Rated 'B'
We raised our existing corporate credit rating on subsidiary At Home Holding III Inc. to 'B' from 'B-' and subsequently withdrew the rating, given we rate the company on a consolidated basis at At Home Group Inc.
In addition, we raised our issue-level rating on the $300 million ($296 million outstanding) first-lien term loan to 'B' from ''B-'. The recovery rating remains '3', indicating our expectation for meaningful recovery of principal in the event of a payment default at the low end of the 50% to 70% range.
We do not rate the company's revolver and second-lien term loan.
The upgrade reflects our expectation for stronger EBITDA margins and profitability as At Home continues to pursue its large-format, high SKU-count store base expansion focusing on maintaining its warehouse-like low service business model in the coming year. In our view, increased marketing efforts, the successful rebranding of the store base, and a focus on annually refreshed, mostly private label merchandise at everyday low prices have been successful with its customers. This is evidenced by healthy 4% comparable sales growth and 25% revenue growth last year, as well as EBITDA margins in the low 20% range, well ahead of home furnishing peers.
We also believe At Home has been taking market share from larger peers such as Pier 1 Imports, smaller format stores, and independent and discount retailers. The company has achieved strong operating results despite high overall competitive pressure in the home decor and furniture sector given the expansion of HomeGoods stores, and online competition from Amazon and Wayfair.
That said, we continue to see execution risks in the company's continued aggressive growth and accompanying high planned capital expenditures, dependence on continued sale leasebacks or mortgages to maintain positive free cash flow, and articulated strategy of limited e-commerce presence. Additionally, although growing, At Home still represents a negligible market share in the widely fragmented home decor space.
Specific assumptions in our forecast for fiscal 2016 include:S&P Global Ratings now expects the economy to grow by 2.0% in 2016 and 2.4% in 2017, with U. S. real GDP and consumer spending remaining in the low-single-digit area;Revenue growth of around 18% in 2016 and 17% in 2017 given we expect same store sales growth in the low single digits in the coming year, with the company adding 22 and 24 net new stores respectively in 2016 and 2017;Adjusted EBITDA margins improve to 24% in 2016 and then soften to 23.7% in 2017 as the company increases its investments in personnel and marketing and improves its direct sourcing capabilities; and No dividends or share repurchases. We expect negative free operating cash flow of about $20 million in 2016, offset with more than $70 million of net proceeds contracted from sale leasebacks in 2016. We expect the company to use proceeds to repay borrowings under the ABL facility and to further invest in new store development.
Offsetting this is a notable improvement in credit metrics given management's commitment to repay debt with IPO proceeds, with leverage declining to 5.1x in the year ending January 2017 from 6.5x at the end of fiscal 2015. We project debt leverage declining to the mid-to high 4.0x in 2017, funds from operations to total debt (FFO/TD) in the 10% to 13% range, and EBITDA interest coverage ratio to remain above 3.0x by the end of fiscal 2017.
Post the IPO, financial sponsor ownership of At Home by AEA Investors and Starr Investment Holdings still remains high at 85% and the private equity sponsors will continue to exercise significant influence over financial and business policies.
The stable outlook on At Home reflects our expectation that the company's unique physical store expansion format, diverse SKU count, and everyday low prices will continue to attract customers in the coming year. However, we remain cautious about the company's aggressive store growth plans, high capital investments, and lack of meaningful e-commerce presence.
We would lower the ratings if At Home is unable to manage growth on a leverage neutral basis, whether from margin dilutive e-commerce expansion or from traffic and average ticket declines that prompt additional promotional selling. This would result in a slowdown of revenue growth to below 14%, gross and EBITDA margin declines of more than 200 basis points, and a leverage increase to the low-to mid 5.0x in the 2017 period. We would also consider a lower rating in the event of a sponsor-led debt-financed transaction.
We could raise the rating if the company improves its operating performance ahead of our expectations through continued strong top line performance and gross and EBITDA margin expansion of more than 80 basis points, leading to a decline in leverage to mid - to high-4x on a sustained basis. Positive free operating cash flows, application of asset sales proceeds to debt reduction, and a further decrease in financial sponsor ownership would also demonstrate the sustainability of an improved financial risk profile in the coming year.