March 14, 2012 / 8:23 PM / 5 years ago

TEXT-S&P affirms BI-LO LLC ratings

Overview	
    -- Shareholders of Winn-Dixie Stores Inc. approved BI-LO LLC's offer to 	
purchase the company and the transaction has subsequently closed. The purchase 	
was partly funded with borrowings drawn from a new $700 million asset-based 	
(ABL) revolving credit facility.	
    -- We are affirming the 'B' corporate credit rating on the U.S. 	
supermarket chain and removing all ratings from CreditWatch with negative 	
implications.	
    -- At the same time, we are revising the recovery rating on the company's 	
$285 million senior secured second-lien notes to '5' from '4' and thereby 	
lowering the issue-level rating to 'B-' from 'B'. 	
    -- The stable outlook incorporates our expectation that the change in 	
operating strategies at Winn-Dixie will not materially weaken operating 	
performance in 2012 and the combined company will moderately grow sales and 	
profits and enhance credit ratios accordingly.	
 	
Rating Action	
On March 14, 2012, Standard & Poor's Ratings Services affirmed the 'B' 	
corporate credit rating on the Greenville, S.C.-based BI-LO, LLC (BI-LO) and 	
removed the ratings from CreditWatch with negative implications. 	
	
At the same time, we revised the recovery rating on the company's $285 million 	
senior secured second- lien notes to '5' from '4' and consequently lowered the 	
issue-level rating on the notes to 'B-' from 'B'. The '5' recovery rating 	
indicates our expectation of modest (10% to 30%) recovery of principal in the 	
event of default, and the notes are now rated one notch below the corporate 	
credit rating. This action comes after the company closed on its purchase of 	
the Jacksonville, Fla.-based Winn-Dixie Stores Inc. (Winn-Dixie).	
 	
Rationale	
The recovery rating on the company's notes reflects our expectation of weaker 	
recovery prospects in the event of a payment default for second-lien note 	
holders, which is a result of the increased priority debt. The combined 	
company now has the ability to borrow up to $700 million on its ABL revolving 	
credit facility, which was previously $100 million. We increased our estimate 	
of the company's enterprise value upon emergence of a default pursuant to the 	
Winn-Dixie acquisition. The increase, however, did not completely compensate 	
for the larger-sized revolving credit facility and therefore worsened the 	
recovery prospects for second- lien note holders, in our view.	
	
The rating reflects our view that the company's financial risk is "highly 	
leveraged" under our criteria, and we anticipate moderate sales and profit 	
gains leading to credit ratio enhancement. However, we do not expect to change 	
our view of the company's financial risk profile over the next year. We also 	
assess the company's business risk profile as "vulnerable," which incorporates 	
the highly competitive nature of the industry, the likelihood of sustained 	
elevated unemployment in the U.S., and the relatively weak operating metrics 	
of the combined company compared with industry peers.	
	
We anticipate that management will use similar operating strategies at 	
Winn-Dixie that BI-LO has used over the past few years, which will entail 	
managing in-store costs more acutely and then employing more competitive 	
pricing strategies. We also expect remodeling activity will be considerably 	
lower at Winn-Dixie. Although BI-LO's recent sales and performance trends have 	
been relatively strong compared with much of the industry, we do not assume 	
that these strategies will have a meaningful effect in 2012. Nonetheless, 	
Winn-Dixie's sales and operating trends have improved over the past three 	
quarters, and we expect Winn-Dixie to maintain a similar sales trajectory over 	
the next year. Our 2012 performance expectations of the combined company 	
include: 	
     -- Low-single-digit comparable-store sales at Winn-Dixie stores--near 2%.	
     -- Mid-single-digit comparable-store sales growth at BI-LO grocery stores.	
     -- No meaningful change in stores or square footage; thus, companywide 	
revenue growth will be slightly higher than that of Winn-Dixie.	
     -- Relatively stable operating margins at BI-LO and slight expansion of 	
margins at Winn-Dixie and at the company overall. We include in this forecast 	
the switch to the first-in, first-out (FIFO) accounting method for cost of 	
goods sold at Winn-Dixie.	
     -- If inventory accounting methods remained the same, there would be a 	
slight operating margin contraction at Winn-Dixie and at the company overall.  	
     -- Cost-cutting and management efforts would partly offset gross margin 	
investments at Winn-Dixie. 	
     -- We also anticipate some benefits from the reduction of duplicative 	
functions, as a result of combining the two companies.	
     -- Thus, overall EBITDA growth will mostly be in line with revenue growth.	
     -- We also expect the company to reduce ABL borrowings with free cash 	
flow.	
 	
With the increased debt to fund the transaction, our performance expectations 	
for pro forma and expected credit ratios at the end of 2012 are outlined below:	
     -- We expect pro forma operating lease-adjusted leverage of 5.7x to 	
improve to 5.3x at the end of 2012. 	
     -- Pro forma adjusted EBITDA coverage of interest to be 2.2x, increasing 	
to 2.5x for the year.	
     -- Funds from operations (FFO) to debt to improve from 14.5% to 15.9% 	
over that period.	
 	
The pro forma leverage and coverage ratios are in line with indicative ratios 	
of highly leveraged financial risk profiles, while the FFO to debt levels are 	
commensurate with indicative ratios of "aggressive" financial risk profiles. 	
However, we also view the company's financial policies as "very aggressive," 	
which is an important factor in assessing the company financial risk profile. 	
	
BI-LO has grown sales better than most industry competitors over the past few 	
years, which we believe is a result of pricing initiatives, the roll-out of 	
its fuelperks! program, and relatively good market presence. More recently, 	
Winn-Dixie has rolled out its fuelperks! program and has made technological 	
investments that should help its inventory management, aiding its sales and 	
operating performance in our view. This should continue in the near term. 	
Moreover, better pricing strategies could lead to further sales gains. 	
Therefore, we believe the combined company may have the opportunity to exceed 	
our performance expectations with greater-than-anticipated sales growth. 	
Conversely, the biggest threat to our performance expectations is that price 	
competition may intensify in the industry as a result of sustained high 	
unemployment and rising gasoline prices. Therefore, both BI-LO and Winn-Dixie 	
will then not be able to pass along higher food costs to consumers, and there 	
will be greater margin contraction than we expected, leading to lower profits. 	
  	
 	
Liquidity	
We view BI-LO's liquidity as "adequate," and we expect its sources of 	
liquidity to exceed uses over the next 12 to 24 months by a ratio of at least 	
1.2x. After the close of the transaction, we expect sources of liquidity to 	
include some excess cash, expected available revolver borrowings of over $300 	
million, and funds from operations. Liquidity uses include capital spending 	
and working capital needs. We also forecast the company will generate 	
meaningful free cash flow, and, given expected capital spending levels, we 	
believe that beginning in 2013, the company can convert between 25% and 35% of 	
EBITDA to free cash flow 	
	
Relevant aspects of BI-LO's liquidity include: 	
     -- We forecast cash sources to exceed cash uses by more than 1.2x over 	
the next 12 months, and to remain above 1.0x over the next 24 months.	
     -- We forecast net sources to remain positive over the next 12 months, 	
even if EBITDA declines 15%.	
     -- The company has no meaningful maintenance financial covenants.	
     -- Sound relationships with the banks in our view.	
 	
Recovery analysis	
For a complete analysis, please see our recovery report, to be published as 	
soon as possible following this report, on RatingsDirect.	
 	
Outlook	
The outlook is stable. This incorporates our expectation that the company will 	
improve credit metrics with moderate profit growth and debt reduction from 	
free cash flow. We would consider a higher rating if management successfully 	
implements its strategic operational initiatives at Winn-Dixie, BI-LO 	
continues with is positive operating trends, and the combined company improves 	
debt leverage to the mid-4x area and FFO to debt to approximately 18%. We 	
forecast this would occur with about 15% EBITDA growth and debt reduction of 	
$125 million. We believe such a scenario could occur in about two years. 	
However, we would want to be sure that the company's financial policies and 	
its private equity sponsor would be such that the company would maintain 	
credit ratios appropriate for a higher rating. 	
	
Conversely, we would consider a lower rating if debt leverage was in the 	
mid-6x area, which could occur with a 15% decline in EBITDA. This could in 	
turn occur with only 1% sales growth and about 50 basis points of EBITDA 	
margin contraction at the combined company.	
 	
Ratings List	
	
Ratings Affirmed; Removed From CreditWatch	
                                        To                 From	
BI-LO LLC	
 Corporate Credit Rating                B/Stable/--        B/Watch Neg/--	
	
Downgraded; Removed From CreditWatch; Recovery Rating Revised	
                                        To                 From	
BI-LO LLC	
 Senior Secured                         B-                 B/Watch Neg	
  Recovery Rating                       5                  4

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