We think it likely that U.K. inflationary pressure in financial year 2011 will have been offset by management's tight cost controlling measures. The company's membership-based operating model for its individual membership (IM) business has continued to exhibit very limited cyclicality, supported by the fact that more than three-quarters of customers renew their policies annually. The corporate partnership (CP) business, which accounts for nearly 40% of annual breakdown sales, won several new mandates in 2011, which largely offset business lost in 2009. We anticipate that RAC's insurance broking business will begin to generate stronger results as it matures and increases in scale.
RAC is the U.K.'s second-largest provider of car breakdown and roadside assistance services, with a low-risk membership-based operating model, national scale, and strong U.K. brand recognition. The company has relatively limited exposure to macroeconomic cycles and benefits from high barriers to entry.
S&P base-case operating scenario
In our current base-case operating scenario, we anticipate that RAC will achieve mid-single-digit revenue growth in the financial year-ending Dec. 31, 2012. The company has been developing and strengthening its sales force, which should support organic revenue growth. At the same time, we also anticipate that Standard & Poor's-adjusted EBITDA will grow to more than GBP110 million.
S&P base-case cash flow and capital-structure scenario
The company generates strong flows and has good potential to deleverage more rapidly than expected. We anticipate that, from time to time, the company may be able to make unscheduled debt repayments and that during financial year 2012, RAC's adjusted debt to EBITDA will improve to less than 9x (including shareholder loans) from just more than 10x, which we forecast for Dec. 31, 2011. We forecast that adjusted funds from operations (FFO) will improve slightly but remain between 5% and 10% in the year to Dec. 31, 2012.
We anticipate that, in the medium term, leverage metrics may be pressured as a result of the accrual of payment-in-kind (PIK) on the shareholder loans, which may potentially outpace EBITDA growth. We treat the interest-accruing shareholder loans as debt under our criteria. We do however note that accrual of interest is PIK, not cash, which is a positive cash flow factor for the company in the short to medium term.
We forecast that the company will remain cash flow positive and that FFO will be between GBP60 million and GBP70 million on Dec. 31, 2012.
We assess RAC's liquidity as "adequate" under our criteria. We anticipate that liquidity sources, including FFO, will exceed uses by more than 2x in financial year 2012.
We forecast that liquidity sources will be about GBP120 million in 2012, including:
-- GBP50 million under an undrawn committed revolving credit facility (RCF), maturing 2015;
-- GBP60 million to GBP70 million of FFO; and
-- Modest inflows from improvements in working capital.
We estimate that RAC's liquidity needs in 2012 will be about GBP60 million, including:
-- Capex in the region of GBP5 million to GBP10 million; and
-- Unscheduled debt repayments of up to GBP50 million.
RAC has negligible annual debt repayments before 2017. Following the group's refinancing in 2011, we believe that headroom under the proposed covenants is likely to remain adequate in the near to medium term.
The issue rating on RAC's GBP50 million RCF, GBP50 million capital expenditure and restructuring facility, and GBP520 million term loan B facility (together, the senior facilities) is 'B+', in line with the corporate credit rating. The recovery rating on these facilities is '3', indicating our expectation of meaningful (50%-70%) recovery in the event of a payment default.
The recovery rating is underpinned by unconditional guarantees from all material subsidiaries (representing at least 80% of EBITDA and gross assets), and by our favorable view of the U.K. jurisdiction from a creditor perspective. At the same time, the recovery rating is constrained by limited freehold asset backing, the fact that the majority of assets pledged are intangibles, and a security package for the senior facilities that only includes a pledge on the nonregulated assets of operating subsidiaries RAC Financial Services and RAC Motoring Services, which are modest in value.
The senior debt facilities incorporate tightening financial covenants and only modest debt incurrence baskets.
In order to determine recovery prospects, we simulate a hypothetical default scenario. Our default scenario assumes that greater competitive pressures could result in the loss of key corporate contracts, which, combined with potentially higher costs, could put pressure on revenues and lead to a default in 2015.
Given the strength of the group's brand and substantial customer portfolio, we value RAC on a going-concern basis. We primarily use a market multiple approach, with an EBITDA multiple of 6.1x at the point of default, based on our analysis of peers with similar business risk profiles. On this basis, we determine a stressed enterprise value of about GBP420 million at our simulated point of default. After deducting GBP21 million of enforcement costs, this leaves about GBP400 million for the senior secured debtholders. Including prepetition interest, the senior secured facilities amount to about GBP650 million, which translates into meaningful recovery of about 50% to 70%.
The stable outlook reflects our opinion that, even taking a conservative view of future growth prospects, RAC should be able to maintain the financial flexibility necessary to service its newly highly-leveraged debt structure. This reflects the group's solid operating track record, positive free cash flow generation, and our view of the stability of its individual membership business model. The outlook also reflects the absence of near-term refinancing challenges, provided that the group maintains adequate headroom under its tightening financial covenants.
We could lower the ratings if poor trading were to weaken the group's liquidity position such that headroom under financial covenants fell to less than 10%, EBITDA cash interest coverage fell to less than 3x, or if funds from operations to net debt (adjusted for leases and the shareholder loan) fell to less than 5%.
Ratings upside is possible in the medium term, in our view, if RAC maintains steady debt deleveraging (to less than 5x including the shareholder loan). However, we do not anticipate this to be a material change unless the shareholder loan is replaced with common equity.
Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated.
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009.
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008