(The following was released by the rating agency)
-- Fertitta Morton's Restaurants recently closed on its acquisition of Morton's Restaurants. At the same time, it refinanced the debt at Claim Jumper.
-- We are assigning our 'B' corporate credit rating to Houston-based restaurant operator Fertitta Morton's, as well as a 'BB-' issue-level rating and a '1' recovery rating to the company's bank credit facility.
-- The rating outlook is stable, and reflects our view that Fertitta Morton's Restaurants will increase earnings through cost-reduction initiatives, allowing the company to maintain healthy credit metrics.
On March 14, 2012, Standard & Poor's Ratings Services assigned its 'B' corporate credit rating to Houston-based Fertitta Morton's Restaurants Inc. The outlook is stable.
At the same time, we assigned our 'BB-' issue-level rating and '1' recovery rating to the company's $215 million senior secured bank credit facility, which consists of a $15 million revolving credit facility due 2016 and a $200 million term loan due 2017. We understand that the company used the proceeds to fund the acquisition of Morton's Restaurant Group, refinance existing debt at Claim Jumper, and pay certain fees and expenses.
Rationale The ratings reflect what we consider Fertitta Morton's Restaurants' "weak" business risk profile (based on our criteria), which incorporates its presence in the highly competitive restaurant industry and exposure to commodity cost swings. The company's brand name recognition and diversity partly offset these weaknesses. The ratings also reflect a "highly leveraged" financial risk profile with thin cash flow coverage ratios. We expect credit measures to improve modestly in the near term, as the company derives benefits from its expense reduction initiatives and uses excess cash flows for debt reduction.
Pro forma for the Morton's Restaurants Group transaction, we anticipate leverage of 6x and funds from operations (FFO) to debt of 9%. Going forward, we anticipate credit measures will improve modestly over the next year. Specifically, we see leverage declining to 5.5x and FFO to debt increasing to about 10.5%. EBITDA margins will grow from 17.2% on a pro forma basis to about 17.9% on profit improvement programs. Key aspects of our expectations are:
-- Revenue growth of about 1% to 1.5%, primarily from organic growth initiatives.
-- No new restaurant openings or additional acquisitions, as we think management will focus on integration.
-- We assume cost reduction targets are achievable because of management's track record at other acquired operations, and that cost-cutting efforts would help to offset food cost inflation.
-- Capital spending of about $12 million, primarily for remodeling initiatives.
-- Free operating cash flow of about $18 million, about half of which the company would likely use for debt reduction.
-- No dividends.
Our rating on Fertitta Morton's Restaurants also incorporates our view of Landry's Inc. (B/Stable/--). Fertitta Morton's Restaurants is an affiliate of Landry's, sharing the same management teams. Landry's has demonstrated its ability to integrate acquisitions without any major issues and has realized meaningful profit growth through cost cuts, increasing efficiency, and obtaining buying synergies. A key risk to our forecast is the potential for management to be distracted by the concurrent integration of the larger size McCormick & Schmick restaurants that Landry's is acquiring. Liquidity We view Fertitta Morton's Restaurants' liquidity as "adequate." This indicates that cash sources should exceed uses over the next 12 months. Key assumptions in our liquidity analysis include the following:
-- Sources will exceed uses by 1.2x or more.
-- Sources would remain positive, even if EBITDA were to contract by 15%.
-- While te company has not yet set terms of the financial maintenance covenants, we anticipate there will be sufficient headroom. Given our operating forecast and debt reduction expectation, we do not anticipate any covenant compliance issues in the next 12 months.
Sources of liquidity include availability under the proposed $15 million revolving credit facility. The credit facility mandates the company to use 50% of excess cash flows for debt reduction, which we think will lead to modestly lower leverage in the near term. Recovery analysis Please see the recovery report on Fertitta Morton's Restaurants, to be published as soon as possible on RatingsDirect after this report. Outlook The outlook is stable. We expect credit measures to improve modestly in the next several quarters, as the company derives benefits from its cost-reduction program and uses excess cash flows for debt reduction. We forecast same-store sales in the 1.0% to 1.5% range, which, combined with menu initiatives and expense reduction, will result in margins in the high-17% area, leverage of 5.5x, and FFO to debt of about 11% by year-end 2012. We would take a negative rating action if same-store sales drop to about negative 10% due to intensified competition, if commodity costs increases by about 100 basis points above our current expectations, or the company pursues a sizable debt-financed acquisition or shareholder distribution, causing leverage to rise above 6x on a sustained basis. We could consider a positive rating action, if, in our assessment, the company's business risk profile strengthens and can support temporary swings in leverage to support growth initiatives.