S&P: Building Materials Distributor 84 Lumber Co. Assigned 'B+' Ratings; Outlook Positive
OREANDA-NEWS. S&P Global Ratings said today that it assigned its 'B+' corporate credit rating to 84 Lumber Co. The outlook is positive. At the same time, we assigned our 'B+' issue-level rating and '3' recovery rating to the company's (with co-borrowers 84 Properties LLC and Pierce Hardy Limited Partnership) proposed $350 million seven-year senior secured term loan. The '3' recovery rating indicates our expectation for meaningful (upper half of the 50%-70% range) recovery in the event of a payment default. 84 Lumber will use the term loan proceeds--along with $350 million of proceeds from a new five-year $350 million asset-based lending (ABL) facility--to repurchase real estate assets previously sold through a sale leaseback transaction in 2007, refinance its existing $350 million ABL facility due 2018, and pay transaction fees and related costs. The 'B+' corporate credit rating on 84 Lumber Co. reflects our view of the company's weak business risk profile and aggressive financial risk profile. The weak business risk profile reflects the still-fragmented nature of the building materials distribution sector, the historically low profit margins inherent in building products distribution, vulnerability to cyclical housing construction cycles, narrow product and market focus in residential construction, and intense competition. Partially offsetting these business risks are 84 Lumber's scale and size as the third-largest building materials distributor in the U. S., with about $2.5 billion of annual revenue; its modest geographic diversity in regional markets in the U. S.; and recently improved profit margins resulting from selling more value-added products and services. Our ratings also take into account our assessment of 84 Lumber's aggressive financial risk profile, which reflects pro forma adjusted debt to EBITDA leverage of about 4.3x and funds from operations (FFO) to debt of about 17%. Our financial risk assessment incorporates our expectation for volatility in 84 Lumber's cash flows given the company's and industry's past volatility of earnings, which are attributable to the highly cyclical single-family residential construction markets. Although we expect a decline in adjusted leverage to below 4x in 2017, intra-year leverage generally increases to over 4x as debt increases to fund seasonal working-capital build-up, which is reduced in the fourth quarter from seasonal cash flows. We expect U. S. housing starts to be about 1.2 million units and U. S. residential construction to improve by 9% in 2016 compared with 2015, with starts increasing to about 1.4 million in 2017. In this environment, we expect the company to post sales of about $2.7 billion for 2016 with EBITDA margins of about 5%, which are in line with the results of other leading building materials distributors. For 2017, if housing starts reach the 1.4 million level, we believe 84 Lumber's EBITDA could increase 20%, with leverage falling below 4x. 84 Lumber is a leading provider of lumber, building materials, trusses, doors, millwork, and construction services to homebuilders, professional contractors, and remodels/renovators. About 10% of the company's sales are also directly to retail project-oriented consumers. The company operates 250 store/distribution locations across 30 states, with roughly half of its stores located in the eastern U. S. The positive outlook reflects our expectation that based on our estimates of 1.4 million housing starts for 2017, 84 Lumber could lower and sustain debt leverage below 4x and FFO-to-debt of above 20%. This would be consistent with a significant financial risk profile and a higher rating. Moreover, we believe there is potential for 84 Lumber to reduce leverage further--to the lower end of the significant range--if housing starts and residential construction activity continue to improve over the next couple of years as expected, with little probability of downward cyclical earnings pressure and increased debt leverage during this recovery period. We could revise the outlook to stable if housing starts in 2016 fail to meet expectations for housing starts and remodeling spending, resulting in flat EBITDA and leverage measures in the upper half of the aggressive range. We would also consider a negative rating action if the company adopted a much more aggressive financial policy, incurring debt to fund dividends or acquisitions, such that EBITDA leverage was sustained above 5x. We would consider an upgrade to 'BB-' if 84 Lumber's operating results continued to improve with increased housing starts, resulting in increased earnings and leverage measures in the lower end of the significant category with debt to EBITDA sustained below 3.5x and FFO-to-debt approaching 25%.