April 5, 2012 / 7:17 PM / 5 years ago

TEXT-S&P revises Norcraft Cos outlook to negative

Overview	
     -- U.S.-based cabinets manufacturer Norcraft Cos. recently acknowledged 	
that its largest customer, DirectBuy, which accounted for 13% of 2011 sales, 	
was undergoing financial difficulties.	
     -- Operating performance is unlikely to improve meaningfully over 2011 	
levels due to still-weak demand and high promotional activity.	
     -- We are affirming our ratings on the company, including the 'B' 	
corporate credit rating.	
     -- We are revising our rating outlook to negative from stable to reflect 	
our assessment that Norcraft's operating performance may be strained due to 	
its DirectBuy exposure as well as the still-weak operating environment.	
 	
Rating Action	
On April 5, 2012, Standard & Poor's Ratings Services revised its rating 	
outlook on Eagan, Minn.-based Norcraft Cos. to negative from stable. At the 	
same time, we affirmed our ratings on the company, including the 'B' corporate 	
credit rating.	
 	
Rationale	
The rating outlook revision reflects our view that operating difficulties 	
could stem from Norcraft's exposure to DirectBuy, its largest customer. 	
DirectBuy, a U.S. consumer buying club, has faced declining membership levels 	
as well as legal issues regarding its sales practices. Standard & Poor's 	
recently withdrew DirectBuy's rating after lowering it to 'D' in February 	
because of a missed interest payment as the company continues to seek a 	
restructuring. Although Norcraft's sales to DirectBuy declined to 13% of sales 	
in 2011, or approximately $35 million, from 16% of sales in 2010, or 	
approximately $42 million, and continued to decline to 10% of sales in the 	
fourth quarter of 2011, Standard & Poor's is concerned that Norcraft's 	
profitability and liquidity could suffer if DirectBuy's financial condition 	
continues to deteriorate.	
	
In addition, we think operating performance during 2012 is unlikely to improve 	
meaningfully over 2011 levels. Repair and remodeling spending--from which 	
Norcraft derives approximately two-thirds of sales--is likely to be flat to 	
slightly up in 2012. Although we project housing starts will grow to 740,000 	
in 2012 from about 610,000 in 2011, much of the growth will be derived from 	
the multifamily sector, and products sold into the multifamily market 	
typically carry a lower margin for Norcraft than products sold into the 	
single-family market. Due to the continued weak demand, promotional activity 	
has remained high in the cabinets industry, which has pressured margins. Until 	
demand materially improves, we expect the high level of promotional activity 	
to continue. In 2011, EBITDA was about $36 million on sales of about $270 	
million, leading to debt to EBITDA of about 7x and interest coverage of less 	
than 1.5x. As a result of our operating expectations (excluding the unknown 	
potential effects from Norcraft's DirectBuy exposure) leverage is likely to be 	
about the same levels as in 2011, which we would consider to be somewhat weak 	
for the 'B' rating.	
	
The 'B' corporate credit rating on Norcraft reflects our view of the company's 	
"weak" business risk profile, which includes participation in the highly 	
cyclical and competitive kitchen installation and remodeling markets, its high 	
exposure to new residential housing starts, its relatively small size and 	
asset base, and its "highly leveraged" financial risk profile. Norcraft 	
manufactures kitchen and bathroom cabinets, and is smaller than its main 	
competitors. This highly fragmented and cyclical industry depends almost 	
exclusively on residential remodeling and new construction. 	
 	
Liquidity	
Given our operating expectations, we believe Norcraft has "adequate" liquidity 	
to meet its needs over the next 24 months. Our view of the company's liquidity 	
profile includes our expectations that:	
     -- Liquidity sources (including availability under the company's $25 	
million revolving credit facility) will exceed uses by at least 1.2x over the 	
next year and 1.0x over the next 18 to 24 months.	
     -- Liquidity sources would continue to exceed uses, even if EBITDA were 	
to decline by 15%.	
 	
The company's primary sources of liquidity for fiscal 2012 include about $24 	
million of cash and about $12 million of availability on its $25 million 	
asset-based revolving credit facility (ABL). The ABL facility is subject to a 	
borrowing base, which is limited to a percentage of eligible accounts 	
receivable and inventory ($16.4 million as of Dec. 31, 2011). Aside from $4.5 	
million in letters of credit outstanding, the company currently has no 	
borrowings on its ABL, and historically, has not used it for short-term 	
borrowings.	
	
Absent the unknown potential effects to Norcraft's liquidity stemming from the 	
company's DirectBuy exposure, we estimate that the company will continue to 	
generate positive free operating cash flow in 2012 and 2013, given minimal 	
working capital needs and annual capital expenditures of about $8 million. 	
Norcraft does not have any maturities until 2015, when its second-lien notes 	
and ABL facility mature. 	
 	
Recovery analysis	
For the most recent recovery analysis, please see the recovery report on 	
Norcraft Cos., published June 2, 2011, on RatingsDirect.	
 	
Outlook	
The rating outlook is negative. Because of the still-weak operating 	
environment, Standard & Poor's believes operating conditions for Norcraft will 	
remain challenging over the next several quarters. We project that the ratio 	
of debt to EBITDA could be about 7x over the next year and interest coverage 	
may be below 1.5x. This is because of our expectation that sales and EBITDA 	
will not materially improve over 2011 levels. Operating difficulties stemming 	
from the company's exposure to DirectBuy could potentially strain 	
profitability and liquidity further. 	
	
We could lower the ratings on Norcraft if DirectBuy's financial condition 	
continues to deteriorate, leading the company to use cash and revolver 	
borrowings to fund operating losses, resulting in a drop in liquidity to 	
materially less than the $36 million of current cash on hand and revolver 	
availability. 	
	
We could revise the outlook to stable if construction end markets and repair 	
and remodeling spending recover more quickly than we currently expect, such 	
that credit measures improve to be more in line with the 'B' rating. We could 	
revise the outlook to stable if adjusted leverage improves to about 5x and 	
interest coverage increases to more than 2x. Additionally, we could revise the 	
outlook to stable if Norcraft is able to increase its market share with other 	
dealers or cut costs to replace potential future lost sales and profits from 	
DirectBuy.	
 	
	
Ratings List	
	
Ratings Affirmed; Outlook Action	
                                        To                 From	
Norcraft Cos. L.P.	
 Corporate Credit Rating                B/Negative/--      B/Stable/--	
	
Ratings Affirmed	
	
Norcraft Cos. L.P.	
Norcraft Finance Corp.	
 Senior Secured                         B                  	
  Recovery Rating                       4

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