Fitch Downgrades BUT's Senior Secured Debt to 'B', Resolves RWN; Affirms IDR at 'B-'
The downgrade reflects Fitch's assumption of lower recoveries for the group's increased senior secured debt following the tap issue. The senior secured debt amount has increased to EUR246m post-tap from EUR180m pre-tap, leading Fitch to assign a Recovery Rating of 'RR3', reflecting a 68% recovery rate, versus 'RR2' (74%) previously, leading to one notch uplift from the IDR as opposed to a two-notch uplift under the previous recovery analysis. The amount, tenor and terms of the tap issue are in line with the existing issue.
Fitch reiterates that the higher secured debt amount can, however, be accommodated within BUT's existing Long-term Issuer Default Rating (IDR), which has been affirmed at 'B-' with Stable Outlook.
The IDR reflects BUT's aggressive leverage and a competitive market characterised by cautious consumer spending and intensifying competition. This elevated financial risk profile is, however, balanced by a satisfactory operating profile, benefitting from operational scale and a strong market and brand position in the French home improvement market, which Fitch expects to further consolidate, with a focus on growth in the value segment.
Since its refinancing in 2014, BUT has implemented a series of self-help measures aimed at improving the group's operational cost base, supply chain and logistics as well as customer offering, which has led to an improved year-on-year profitability and cash generation. This was aided by improving consumer sentiment in France. However, the rating headroom created has been largely absorbed by the additional tap issue, which is expected to support further investment in the business, including acquisitions, underpinning the 'B-' IDR.
KEY RATING DRIVERS OF THE IDR
Aggressive Financial Profile
Fitch expects funds from operations (FFO)-adjusted gross leverage for the financial year 2015 (year end June) to have improved to just under 6.0x (FY14: 7.0x) and FFO fixed charge cover (FCC) to 1.5x (1.2x), increasing rating headroom relative to the agency's rating sensitivities. However, we expect FFO gross leverage to increase by up to 0.5x and FCC to fall just below 1.5x in FY16 resulting from higher debt levels post tap and assuming reinvestment of the proceeds in the business. This leaves debt protection ratios comfortably within the 'B-' rating level which supports a Stable Outlook.
Last year's refinancing left BUT with fairly manageable on balance-sheet debt, although high rental expenses translate into an aggressive financial risk profile. This is reflected in the group's low lease-adjusted debt protection ratios, which Fitch has conservatively based on the full value of 'occupancy costs' as presented by management.
Evolving Business Model
Management continues to successfully focus on streamlining BUT's product offering and optimising cost and cash management by simplifying its supply chain and centralising the logistics function domestically. In addition, it is aiming to increase direct control over its brand and store appearance by moving away from the traditional franchise model and taking a more centralised approach to key management decisions including range, pricing, marketing and multi-channel offering.
The evolving business model and operating efficiencies, including a strong focus on working capital, have strengthened underlying profitability and cash generation. For FY15 Fitch estimates like-for-like sales growth of 1.8%, a 100bps EBITDA margin improvement and a free cash flow (FCF) margin trending towards 2%.
Profitability Supported by Consumer Financing
Credit income generated from consumer financing supports EBITDA, adding approximately 100bps to the EBITDA margin. Consumer finance is a key part of BUT's promotional activity, a strong sales driver, and a source of differentiation against competitors with a 25% credit penetration rate of its customer base. Given the integral role of consumer finance in BUT's business model and the ring-fenced nature of the associated credit risk, Fitch includes the consumer finance contribution in its operating EBITDA calculation.
The group offers consumer finance products (including store cards, instalment loans, personal loans) in combination with Cetelem (the consumer finance arm of BNP Paribas Personal Finance), which manages credit risks on a non-recourse basis for BUT. In addition, BUT offers appliance warranties, which are managed via an in-house insurance vehicle. The consumer finance and insurance arrangements are subject to regulatory risks.
Asset Light Business Mode
Since its original buy-out in 2008, BUT has gradually implemented an 'asset-light' business model by selling and leasing back assets, particularly with regard to its owned store network and logistics operations. The key assets in the business therefore remain the brand value and inventory, which is reflected in Fitch's debt protection ratio analysis (adjusted for lease obligations) and recovery analysis. While an asset-light capital structure is not uncommon in non-food retail, it leads to pressures on profitability and cash flows due to high rental costs. This translates into high operating leverage and potentially a volatile earnings profile in a downturn.
Concentration on France, Competitive Pressures
Limited geographic diversification and concentration on the French retail market are a key rating constraint. This is particularly true in a subdued, albeit stabilising, French consumer environment. In addition, Fitch expects further medium-term consolidation and competitive pressures at the value end of the home equipment market in France.
The home equipment market in France is dominated by BUT and two other players with a combined share of more than 45%, at the expense of independent and local retailers. Fitch believes that in this context BUT's strategy to concentrate on network expansion in smaller cities is sensible in that it should help boost and defend its market share.
Established Brand and Market Position
The ratings reflect BUT's position as a leading home equipment retailer in France, with a strong nationwide store footprint and a diversified product range spanning home furnishing and decoration, domestic appliances as well as select home-related consumer electronics. BUT's promotional-driven business model is supported by a strong and well-recognised retail brand.
KEY RATING DRIVERS OF THE NOTES
Fitch believes that expected recoveries would be maximised in a going-concern scenario rather than in liquidation given the asset-light nature of BUT's business, where Fitch views the brand value and established retail network as key assets. Fitch estimates that senior secured noteholders, following the successful tap issue, can expect a recovery rate of 68% (equivalent to RR3), leading to a one-notch uplift for the senior secured instrument rating from the IDR to 'B'. Fitch's underlying recovery assumptions remain unchanged, with a 35% distressed EBITDA discount and 4.5x EV/EBITDA multiple and that the proceeds raised by the tap issue will be invested in the business, including acquisitions.
The expected senior secured debt recovery is underpinned by guarantors representing at least 85% of the group's EBITDA and by noteholders' second-ranking claim on any enforcement proceeds in a distressed sale of assets or the business.
Fitch's expectations are based on our internally produced, conservative rating case forecasts over the four-year rating horizon. They do not represent the forecasts of rated issuers individually or on aggregate. Key Fitch forecast assumptions include:
- Moderate like for like sales growth, below GDP growth assumptions
- Stable EBITDA margins reflecting the benefits achieved in FY15 mitigated by competitive pressures and consolidation in the French home equipment market
- EUR66m tap issue to be invested in the business including acquisitions
- Continued focus on supply chain and working capital management
- Disciplined approach to capex representing 1.9%-2.2% of annual sales
Future developments that, individually or collectively, could lead to positive rating action include:
- FFO adjusted gross leverage at 6x or below, FFO fixed charge cover at above 1.5x, combined with market share gains and improvements in FCF generation and operating profitability, all on a sustained basis
Future developments that, individually or collectively, could lead to negative rating action include:
- FFO gross lease adjusted leverage of 7.0x or above on a sustained basis
- FFO fixed charge cover of 1.0x or below on a sustained basis
- A significant deterioration in market share, revenues and/or operating profitability
- Negative FCF eroding the group's liquidity buffer
Fitch views BUT's liquidity as adequate in its rating case projections, supported by the availability of a EUR30m RCF and reported cash on balance sheet of EUR108m (FYE14). Of this amount Fitch deducts EUR40m as not readily available cash to allow for seasonal working capital fluctuations and restricted cash related to consumer financing. Even so, liquidity is adequate as BUT does not face any meaningful debt redemptions until 2019.