S&P: European Jewelry Retailer THOM Europe 'B' Ratings Affirmed On Tap Issuance Transaction Announcement; Outlook Stable
At the same time, we affirmed our 'B' issue rating on THOM Europe's senior secured notes due 2019, including the €190 million of additional debt due to be raised through a proposed tap issuance. The recovery rating on the notes is '4' reflecting our expectation of average recovery prospects in the higher half of the 30%-50% range.
We also affirmed our 'BB-' issue rating on THOM Europe's super senior revolving credit facility (RCF) due 2019. The recovery rating is '1', indicating our expectation of very high recovery prospects in the higher half of the 90%-100% range.
Our affirmation follows THOM Europe's announcement that it plans to raise €190 million of senior secured notes via a tap issuance of its existing notes. Although we expect that leverage will increase post-transaction, we forecast THOM Europe's credit metrics will remain within our expectations for the current 'B' rating. The acquisition of Stroili Oro is funded by a combination of debt and equity. In our view, the financial sponsor's equity contribution of about €67 million supports the commitment to the current rating. Proceeds will be used as part of the funding strategy in the acquisition of Italy-based Stroili Oro; specifically to finance the €147 million purchase price of Stroili and to repay €116 million of Stroili debt under its syndicated loan facilities. The senior notes will form part of the combined group's capital structure post-acquisition.
Post-acquisition, we continue to view THOM Europe's business risk profile as being in the fair category. In our opinion, the businesses are complimentary, given Stroili Oro's leading position in Italy, where THOM Europe previously had a modest presence. The acquisition adds sizable scale and broadens the company's geographic footprint with the combined group representing a network of 948 stores across France, Italy, Belgium, and the Netherlands. The acquisition allows THOM Europe to immediately gain market share in Italy and provides an opportunity for it to implement its inventory systems and gain synergies through operating a group with greater scale and purchasing power. We consider a transaction of this magnitude carries the execution risk of successfully integrating Stroili Oro into an established group. That said, we acknowledge management's track record of previously integrating the Marc Orian and Piery businesses, together with the retention of key management personnel at Stroili Oro, which should facilitate a smooth integration.
The fragmented nature of the jewelry retailing sector and its sensitivity to declines in disposable income, given that jewelry is non-essential and easily substitutable, also form part of our assessment of THOM Europe's fair business risk. The high seasonality of the sector, with the majority of earnings generated in the fourth quarter of the calendar year, can result in greater cash flow volatility. The penetration of online distribution in the jewelry sector continues to lag other retail segments. Although competitive pressure from online selling continues to increase, THOM Europe's online presence remains limited.
Post transaction, THOM Europe's financial profile will remain commensurate with our highly leveraged category. In our base-case forecast, the combined group's adjusted debt-to-EBITDA ratio will increase to about 4.7x in fiscal 2017 (ending Sept. 30) on an S&P Global Ratings-adjusted basis (on a reported basis, which includes about €290 million of convertible bonds, we expect debt to EBITDA to remain above 7x). We also expect EBITDA before rent costs (EBITDAR) cash interest plus rent coverage of between 1.5x and 1.7x in fiscal 2017. Our view of the company's financial profile also incorporates our view of the company's financial policy and financial sponsor ownership.
Our base case assumes:Our expectation of persistently soft macroeconomic conditions; France GDP growth of 1.5% in 2016, slowing to 1.2% in 2017. Italian growth to also decelerate, at 1.1% in 2016 falling to just 0.8% growth in 2017.Continued revenue growth to be achieved via THOM Europe's store expansion strategy, supported by the addition of the Stroili Oro store network, of about 370 points of sale. Capital expenditure (capex) of about €25 million-€35 million per year; andS&P Global Ratings-adjusted EBITDA margin of the combined group to commence at about 25%-26% in 2017, given our expectations of additional costs to be incurred and to subsequently improve toward 28% in 2018, once the negative effect of additional costs and additional synergies are derived. Based on these assumptions, and following the expected completion of the transaction, we arrive at the following credit measures for 2017 and 2018:Funds from operations (FFO) to debt of about 12%-16% in 2017 and 2018; Adjusted debt to EBITDA of 4.5x-5.0x in 2017, improving to between 4.0x and 4.5x in 2018; Adjusted EBITDA-to-interest ratio of about 3.0x;Unadjusted EBITDAR cash interest plus rent coverage of about 1.5x-1.7x; andPositive free operating cash flow (FOCF) of up to €40 million. The stable outlook reflects our view that the acquisition of Stroili Oro will enable THOM Europe to further consolidate its market position, thereby translating to a higher baseline level of earnings and positive FOCF generation. It also reflects our view that the retention of key management personnel at Stroili Oro will facilitate a smooth integration process, enabling the combined group to achieve future growth via store openings and positive trading. We forecast that in the next 12 months, the group will achieve a debt-to-EBITDA ratio of between 4.5x and 5.0x on an S&P Global Ratings-adjusted basis, and EBITDAR cash interest plus rent coverage of between 1.5x and 1.7x.
We could consider raising the rating if THOM Europe successfully solidified its market position, supported by a track record of sound underlying performance. This would be supported by like-for-like growth and meaningfully positive FOCF, together with strengthening credit metrics, in particular adjusted debt to EBITDA approached 4.0x and EBITDAR coverage approached 2.2x. Any upgrade would hinge on our view that the risk of releveraging is low, based on our assessment of the company's financial policy.
We could lower the ratings if the integration of Stroili Oro faltered or if weaker economic conditions resulted in materially weaker operating performance, including lower margins and cash flows, which could lead to deterioration in the company's business risk profile. Downward rating pressure could also arise as a result of sustainably weaker credit metrics or a deterioration in THOM Europe's liquidity position. In particular, if EBITDAR cash interest plus rent cover approached 1.2x, or the company was unable to sustain positive FOCF.