RON.PR.A Downgraded to Pfd-4(high), Trend Negative by DBRS

DBRS has announced that it:

downgraded the Issuer Rating and Senior Unsecured Debt rating of RONA inc. (RONA or the Company) to BB (high) from BBB (low) and the Preferred Shares rating to Pfd-4 (high) from Pfd-3 (low), maintaining the Negative trend. DBRS has also assigned a recovery rating of RR2 to the Company’s Senior Unsecured Debt.

On May 30, 2012, DBRS confirmed RONA’s Senior Unsecured Debt and Preferred Shares ratings at BBB (low) and Pfd-3 (low), respectively, and maintained the Negative trend. Such rating actions considered the Company’s announced restructuring plans as well as the change in capital structure undertaken with the early repurchase of debentures, but also reflected continued uncertainty with respect to RONA’s ability to improve its operating performance in a challenging consumer and competitive environment. At that time (Q1 F2012), DBRS stated that should RONA not be successful in improving its credit metrics due to weakness in operating income and/or more aggressive-than-expected financial management, a downgrade would likely result.

Subsequent to that statement, RONA released year-end F2012 results, which delivered a net sales increase of 1.7%, flat same-store sales and a significant 40% decline in EBITDA to $171 million versus $285 million in 2011. EBITDA margins were negatively affected by weaker gross margins due to promotional activity in a highly competitive environment and higher selling, general and administrative costs. This marks the third consecutive year of declining EBITDA and EBITDA margins.

As such, combined with an increase in balance-sheet debt to approximately $328 million at year-end 2012 from $257 million the previous year (at least partially due to incremental debt used to complete $67 million of share repurchases in 2012), lease-adjusted debt-to-EBITDAR increased to approximately 3.77 times (x) versus 2.54x in 2011 and 2.80x in 2010 (the improvement in lease-adjusted debt-to-EBITDAR in 2011 was largely attributable to the Company’s repurchase of a portion of its outstanding debentures), while lease-adjusted EBIT coverage declined to 1.51x in 2012 versus 2.26x in 2011 and nearly 3.7x in 2010. Furthermore, the Company’s ability to deleverage over time has weakened considerably as indicated by its free cash flow as a percentage of debt (nearly 18% in 2012 versus approximately 42% in 2011 and 25% in 2010).

DBRS believes that the continued deterioration in operating performance, which has prevented the Company from delivering growth in sales (coupled with margin expansion and weakness in key credit metrics), has resulted in a credit risk profile that is no longer consistent with a BBB (low) Issuer Rating. DBRS believes that the consumer and competitive environment in Canada will remain difficult going forward as The Home Depot, Inc. (rated A (low), Stable) continues its strong performance (five consecutive quarters of positive comparable store sales in Canada) and Lowe’s Companies, Inc. examines continued expansion in Canada to gain necessary scale.

On February 21, 2013, RONA announced further restructuring efforts in the form of its Transformational Strategy, which is expected to span from 2013 to 2015. The plan builds on previous restructuring efforts and includes a rationalization of the Company’s administrative support model, which could ultimately benefit EBITDA by 15% in the near-to-medium term. In addition, RONA plans to enhance the customer experience by improving its merchandising, pricing strategy and in-store service. The Company also plans to optimize its stronger commercial and professional market division and rationalize its underperforming big-box network outside of Québec. Finally, the Company will seek to strengthen and better leverage core markets where profitability has been strong (i.e., distribution to dealers, proximity stores and banners in Québec).

In terms of outlook, DBRS has maintained the trend at Negative as we continue to believe meaningful recovery will remain challenging. RONA is expected to face intense competition in an environment that should remain highly promotional, with consumers facing significant challenges. Although DBRS recognized the merits of RONA’s Transformational Strategy and the cost savings that could result, DBRS expects that a significant improvement in performance will be difficult to realize over the near-to-medium term.

In order for the trend on its credit risk profile to stabilize, RONA would need to demonstrate signs of stabilizing and/or expanding same-store sales and margins leading to a recovery in operating income and return on invested capital, within the context of the Company’s consolidation efforts.

If the Company’s plans and performance lead to stabilization of same-store sales, operating income and key credit metrics, the ratings outlook could stabilize. Continued and meaningful deterioration in same-store sales and/or operating margins and key credit metrics (i.e., lease-adjusted EBIT coverage, free cash flow as a percentage of debt and lease-adjusted debt-to-EBITDAR over 4.0x) in the near-to-medium term could result in another downgrade to BB and Pfd-4.

RON.PR.A was last mentioned on PrefBlog when it was downgraded to Pfd-3(low) in November 2011. RON.PR.A is a FixedReset, 5.25%+265. It is tracked by HIMIPref™ but is relegated to the Scraps index on credit concerns. It closed on 2013-3-11 at 25.61-70 to yield 4.01%-3.99% to perpetuity.

It was also mentioned in the December, 2012, PrefLetter as being a rather peculiar issue for ZPR to be holding (0.51% of portfolio) since the TXPL methodology states:

Rating. Preferred shares must have a minimum rating of P-3 or its equivalent by Standard & Poor’s, Dominion Bank Ratings Service or Moody’s Investor Service.1 If more than one of the ratings agencies has issued a rating on the stock, the lowest rating is used to determine eligibility.

One Response to “RON.PR.A Downgraded to Pfd-4(high), Trend Negative by DBRS”

  1. […] After the close it was downgraded to Pfd-4(high) by DBRS. […]

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