(The following statement was released by the rating agency) Overview
-- Dallas-based Roofing Supply Group LLC (RSG) plans to increase its seven-year bank term loan B by $25 million to $315 million and will utilize proceeds to repay revolving credit borrowings.
-- We are assigning our 'B' issue-level rating to the proposed $315 million senior secured bank term loan B. We are also affirming our other ratings on RSG, including our 'B' corporate credit rating.
-- The stable rating outlook reflects our expectation that the company will continue to generate modest positive free cash flow and maintain strong liquidity while reducing total adjusted leverage to 5.5x or below by the end of 2013.
Rating Action On Oct.3, 2012, Standard & Poor's Ratings Services assigned a 'B' issue-level rating (the same as the corporate credit rating) to RSG's proposed $315 million seven-year senior secured bank term loan B. The recovery rating is '3', indicating our expectation of a meaningful (50% to 70%) recovery for lenders in the event of a payment default. At the same time, we affirmed our existing ratings on RSG, including the 'B' corporate credit rating. The outlook is stable.
The affirmation of our existing ratings and the assignment of the 'B' issue level rating on the upsized term loan on RSG reflect our assessment of the company's "weak" business risk profile and its "highly leveraged" financial profile. Our financial risk assessment reflects current total debt/EBITDA leverage (adjusted for operating leases) of about 6x, which resulted from Clayton, Dubilier & Rice'spartially debt financed acquisition of the company earlier this year.
Our business risk assessment incorporates modest but improving operating profitability as a distributor, geographic diversity limited to the U.S., a relatively small size and scale of operations, highly competitive end markets, and exposure to volatile construction cycles and unpredictable weather patterns.
Our baseline scenario assumes that RSG's sales will be flat to slightly down in 2012 due to lower demand caused by less storm activity and slightly lower average selling prices. Higher demand caused by increased housing starts partially offset the decline in repair-related activity. Our economist currently expects starts to rise 24% from 2011 levels to 760,000 in 2012.
For 2013, we project sales to increase 5% to 10% based on our economist's projection of 930,000 housing starts and mid-single digit increase in residential repair and remodeling driven by a slowly recovering economy. As a result, we estimate leverage, currently about 6x, to increase slightly by year-end 2012 due to the additional term loan borrowings and reduced EBITDA compared with last year's unusually strong performance as a result of excess storm activity. We expect credit measures to improve in 2013 as housing starts increase and consumers spend more on deferred roof replacements, with leverage, improving to about 5.5x or less by the end of 2013. We also expect interest coverage to be about 3x and funds from operations (FFO)-to-total debt to be between 10% and 15% by that time.
RSG benefits from relatively stable demand because more than 80% of its current sales come from necessary repairs and replacement, which we view as largely non-discretionary. We are maintaining a positive long-term view of the roofing industry, given an aging housing stock and high percentage of replacement business. Weather can also significantly affect sales, as repairs required after hurricanes and other severe storms often cause an increase in roofing sales, and stable weather patterns can result in less demand. Still, the market is highly fragmented, and RSG faces intense competition from both larger, better capitalized companies and smaller local players.
RSG is the fourth-largest distributor of roofing materials and supplies in the U.S., with 59 branches in 26 states serving a diverse group of roofing contractors, home builders, and retailers.
We believe the company has a strong liquidity profile due to a very favorable capital structure (with minimum debt maturities and capital spending requirements over the next several years), no financial ratio maintenance requirements, positive cash flow generation, and significant availability under its $175 million asset-based revolving credit facility.
Our view of the company's liquidity profile takes into consideration the following factors:
-- We expect that liquidity sources (including cash, discretionary cash flow, and availability under its $175 million ABL revolving credit facility) will exceed uses by 1.5x over the next 12 months and 1x over the next 24 months.
-- We expect that liquidity sources will continue to exceed uses, even if EBITDA were to decline by 30%. Given the company will not be subject to financial ratio maintenance covenants, we would not view liquidity as impaired following a 30% drop in EBITDA.
Based on our baseline scenario, we expect discretionary cash flow of about $35 million in each of the next two years, which would easily cover annual CAPEX requirements of about $5 million to $7 million per year, with the difference ($25 million to $30 million) to be available for reduction of term loan principal.
The company also has a $175 million asset-based (ABL) revolving credit facility due 2017. The company generally borrows in the $20 million to $30 million range during the first half of the year to fund seasonal growth, which usually reverts in the fourth quarter of the calendar year through cash collections. Cash balances are generally minimal until the fourth quarter.
The company's liquidity also benefits from the proposed capital structure with only a fixed-charge requirement effective when availability under the ABL facility falls below minimum levels. Also, the company will have no debt maturities until 2017 when its ABL matures.
Required amortization under the term loan will total $3.1 million per year. CAPEX requirements are very modest at $5 million to $7 million per year. We do not anticipate any dividend return to owners in the next one-two years. We think the company will do small bolt on acquisitions, probably totaling $25 million or less in total and funded out of discretionary cash flow.
Recovery analysis Standard & Poor's Ratings Services assigned a 'B' issue-level rating (the same as the corporate credit rating) to RSG's proposed $315 million seven-year senior secured bank term loan B. The recovery rating is '3', indicating our expectation of meaningful (50% to 70%) recovery for lenders in the event of a payment default. For the complete recovery analysis, see Standard & Poor's recovery report on Roofing Supply Group LLC to be published on RatingsDirect after this report.
The outlook is stable. We expect end-market demand for RSG's products to be relatively flat over the next 12 months because expected increases in demand are likely to be offset by less storm activity compared with an unusually active 2011. As a result, we expect credit metrics to remain in line with a highly leveraged financial risk profile, with adjusted leverage about 6x for 2012 and improving to about 5.5x or less by the end of 2013. In addition, we believe liquidity in terms of cash, availability under the revolving credit facility, and cash flow from operations will be more than sufficient to meet the company's seasonal working capital needs and other obligations.
We could raise the ratings if RSG's operating prospects during the next several quarters exceed our current expectation due to stronger-than-expected housing starts and higher roof replacement volumes because of increased consumer confidence. Under this scenario, the company's adjusted leverage could trend towards 5x or below more quickly than we currently anticipate.
Although we think a downgrade is unlikely in the near term, we could take a negative rating action over the next year if liquidity unexpectedly falls due to a large drop-off in revenues caused by renewed recessionary pressures, which would cause the company's borrowing availability under its ABL facility to contract. Specifically, we could take a negative action if total liquidity was less than $60 million as the company entered its working capital growth season. We could also lower the rating if the company pursued an aggressive debt financed acquisition or dividend policy, causing leverage to exceed 7x.
Related Criteria And Research
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
Ratings List Ratings Affirmed Roofing Supply Group LLC Corporate credit rating B/Stable/-- Roofing Supply Group LLC Senior secured B Recovery rating 3 Senior unsecured CCC+ Recovery rating 6 New Rating Roofing Supply Group LLC Senior secured $315 mil. bank term loan due May 2019 B
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. All ratings affected by this rating action can be found on Standard & Poor's public Web site at . Use the Ratings search box located in the left column. (New York Ratings Team)