(The following statement was released by the rating agency)Overview
-- U.S. fabrics and crafts retailer Jo-Ann Stores Inc.'s indirect parent,Jo-Ann Stores Holdings Inc. (Holdings) is issuing $325 million of seniorunsecured PIK notes to finance a dividend to equity holder Leonard Green &Partners.
-- We are assigning a 'B' corporate credit rating to Holdings and a'CCC+' issue-level rating to the proposed notes.
-- We are affirming our ratings on Jo-Ann Stores, including the 'B'corporate credit rating, and revising the outlook to stable from positive.
-- The stable outlook reflects our view that the proposed debt issuancewill cause financial ratios to improve, but to remain within levels indicativeof a "highly leveraged" financial risk profile.
Rating ActionOn Oct. 9, 2012, Standard & Poor's Ratings Services affirmed its 'B' corporatecredit rating on Hudson, Ohio-based Jo-Ann Stores Inc. and revised the outlookto stable from positive. In addition, we are assigning a 'B' corporate creditrating to Jo-Ann Stores Holdings Inc. (Holdings).
We assigned a 'CCC+' (two notches below the corporate credit rating)issue-level rating to the company's proposed $325 million senior unsecuredpaid-in-kind (PIK) notes due 2019. The recovery rating is '6', indicating ourexpectation of negligible (0% to 10%) recovery for noteholders in the event ofa payment default.
At the same time, we affirmed the 'B+' (one notch above the corporate creditrating) issue-level rating on the company's $650 million senior secured termloan B facility due 2018. The recovery rating is '2', indicating ourexpectation of substantial (70% to 90%) recovery for lenders in the event of apayment default. We also affirmed the 'CCC+' (two notches below the corporatecredit rating) issue-level rating on the company's $450 million seniorunsecured notes due 2019. The recovery rating is '6', indicating ourexpectation of negligible (0% to 10%) recovery for noteholders in the event ofa payment default.
The rating action reflects our view that the company's financial ratios willweaken following the proposed debt issuance, but will return to near currentlevels over the next 12 months, including adjusted total debt to EBITDAapproaching 7x after the debt issuance that improves to near 6x. We no longerforecast an improvement in the company's financial ratios to levelsindicative of an "aggressive" financial risk profile under our criteria, whichwas the primary basis for our previous positive outlook. Profit growthremains the primary driver of ratio improvement in our view.
Our ratings on Jo-Ann Stores reflect its "weak" business risk profile and"highly leveraged" financial risk profile under our criteria. Our businessrisk assessment reflects our analysis that the company needs to make continuedcapital investment in store enhancements to maintain its competitive position.It also reflects Jo-Ann's participation in the competitive and highlyfragmented craft and hobby retail industry, as well as the seasonal nature ofits earnings. Our financial risk assessment reflects our expectation forfinancial policies to remain very aggressive under financial sponsorownership, as confirmed by the proposed debt-financed dividend. Given thisproposed issuance, we now forecast that financial ratios will improve butremain within levels indicative of a highly leveraged financial risk profile.Below is our revised financial ratio forecast for fiscal year-end January 2013and for fiscal year-end January 2014, respectively:
-- Lease-adjusted total debt to EBITDA increases to nearly 7x from nearly6x, and recedes to 6.3x by fiscal year-end January 2013 and to 6.0x by fiscalyear-end January 2014. Our prior forecast was for leverage to decrease to 5.6xand then to 5.2x, respectively.
-- Funds from operations (FFO) to total debt falls to 12.0% from 14.2%,and increases to 12.3% by fiscal year-end January 2013 and then to 12.6% byfiscal year-end January 2014. Our prior forecast was for FFO to total debt toincrease to about 15% and then to nearly 16%, respectively.
-- EBITDA coverage of interest falls to 2.0x (pro forma to reflect thefull interest expense impact of the proposed issuance) from 2.3x, andincreases to 2.4x by fiscal year-end January 2013 and then falls to 2.3x byfiscal year-end January 2014 as the full interest expense impact is reached.Our prior forecast was for EBITDA coverage of interest to increase to 2.5x andthen to 2.7x, respectively.
Financial ratios indicative of a highly leveraged financial risk profileinclude total debt to EBITDA above 5x and FFO to total debt below 12%.Financial ratios indicative of an aggressive financial risk profile includetotal debt to EBITDA between 4x and 5x and FFO to total debt between 12% and20%.
Standard & Poor's economists believe the risk of another U.S. recession duringthe next 12 months is between 20% and 25%. We expect GDP growth of just 2.2%this year and only 1.8% in 2013, consumer spending growth of between 2.0% and2.3% per year through 2013, the unemployment rate remaining at or above 8%through late 2013, and crude oil (WTI) finishing 2012 at $93.75 per barrel andfinishing 2013 at $89.68 per barrel. (See "U.S. Economic Forecast: He's BuyingA Stairway To Heaven," published Sept. 21, 2012.) Considering these economicforecast items, our base-case forecast for the company's operating performanceover the next two years is as follows:
-- Revenue growth in the mid-to-high-single-digit percent area. Fiscal2013 growth is boosted by an extra week; the company's plan to continue addingnew stores and remodeling existing ones also provides a boost in both years.
-- Gross margin is slightly higher, as elevated input costs continue topartly offset modest gains from private-label and direct-sourcing initiatives.
-- Operating expenses grow at a slower rate than revenue, with growthprincipally from store development initiatives.
-- Debt repayment is limited to contractual debt amortization.
We view the company's financial policies to be very aggressive, primarilybecause of the majority equity ownership by the financial sponsor, LeonardGreen & Partners L.P. This view incorporates our expectation for Jo-Ann toprioritize capital investments and dividends over accelerated debt repayment,a strategy that is evident in the proposed debt-financed dividend. LeonardGreen took Jo-Ann Stores private through a leveraged buyout in March 2011.
The business risk assessment incorporates our opinion that the industry willremain competitive and highly fragmented. We believe the top three companiescontrol about one-third of industry share, with Jo-Ann Stores trailingMichaels Stores and Hobby Lobby. We believe these three companies willcontinue to invest in store expansion to gain industry share and to contributeto growth.
Jo-Ann is highly dependent on discretionary consumer spending, and we believethe company relies on a loyal, yet narrow base of repeat customers for growth.For same-store sales growth to consistently exceed GDP growth, the companywill need to expand its customer base and broaden its customer profile, likelythrough targeted marketing campaigns via multiple channels. We believe suchinitiatives are under way, but it is still too early to gauge the potentialbenefits.
There is significant seasonality in the company's business. The majority ofsales take place in the third and, to a greater extent, fourth quarter.Heightening this risk is the long ordering lead times the company's suppliersrequire. For example, holiday season merchandise is typically ordered inFebruary or March. As such, misjudging consumer preference or demand couldhave a material adverse impact on financial results.
We believe the company will be able to continue to benefit from operatingexpense leverage, though not to the extent achieved in recent years. Anenhanced store base and increased direct sourcing of products has helpedprofitability. We calculate gross margin has improved by about 350 basispoints since fiscal 2007, and we believe increased direct product sourcingcontributed meaningfully to this improvement. The company has also efficientlymanaged its operating expenses. Since fiscal year 2007, operating expenseshave increased at a compound annual growth rate (CAGR) of less than 1.5% whilerevenue has increased at a CAGR of about 3.5%.
We believe Jo-Ann Stores has adequate liquidity, with cash sources expected toexceed cash uses over the next 24 months. Cash sources primarily includesurplus cash, funds from operations, and revolver availability. Cash usesprimarily include working capital, capital expenditures, and debtamortization. Our liquidity assessment includes the following factors,expectations, and assumptions:
-- We forecast cash sources to exceed cash uses by more than 1.2x overthe next 12 months and to remain positive over the next 24 months.
-- We forecast net sources would remain positive even if EBITDA were todecline 15%.
-- We believe the company will maintain excess availability under itsrevolving credit facility so that no material financial ratio maintenancecovenants would apply.
-- Contractual debt amortization is low at $6.5 million per year.
-- Debt maturities are favorable, with the revolving credit facility duein 2016, term loan due in 2018, the senior notes due in 2019, and the proposedsenior unsecured PIK notes due 2019.
As of July 28, 2012, we calculate total liquidity of nearly $320 million, withrevolver availability of nearly $300 million. Revolver availability is anaverage of $285 million over the past four quarters, and total liquidity hasbeen above $300 million over the past three quarters. Liquidity will fall inthe third quarter as the company prepares for its busy holiday season.
We forecast the company can generate positive free cash flow, even afteraccounting for its store expansion and remodel plan. However, after accountingfor the proposed dividend, discretionary cash flow, on a cumulative basis, isforecast to remain negative for at least the next three years. This alsoassumes no additional dividends are paid over the next three years.
Recovery analysisFor the complete recovery analysis, please see the recovery report on Jo-AnnStores, to be published on RatingsDirect following this report.
The outlook is stable, reflecting our forecast that the proposed debt issuancewill lead to some improvement in financial ratios, but they will remain withinlevels indicative of a highly leveraged financial risk profile.
We could lower our ratings if positive operating performance stalls orworsens, causing financial ratios to remain near pro forma levels, includingadjusted leverage in the high-6x area.
We could raise our ratings if operating performance exceeds our currentexpectations or, though we consider this less likely, if a change in financialpolicies allows financial ratios to reach levels indicative of an aggressivefinancial risk profile, including adjusted leverage of 5x. Based onsecond-quarter fiscal 2013 results and pro forma for the proposed debtissuance, EBITDA growth of about 37% or debt reduction of nearly $600 millionis necessary for adjusted leverage to reach 5x.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Liquidity Descriptors for Global Corporate Issuers, Sept. 28, 2011
4765458&rev_id=11&sid=805195&sind=A&", April 15, 2008
Ratings Affirmed; Outlook Action
To FromJo-Ann Stores Inc.Corporate Credit Rating B/Stable/-- B/Positive/--Ratings AffirmedJo-Ann Stores Inc.Senior Secured B+Recovery Rating 2Senior Unsecured CCC+Recovery Rating 6New RatingJo-Ann Stores Holdings Inc.Corporate Credit Rating B/Stable/--
Sr unsecured $325 mil 8.75% due 2019 CCC+
Recovery Rating 6
Complete ratings information is available to subscribers of RatingsDirect onthe Global Credit Portal at
. All ratings affectedby this rating action can be found on Standard & Poor's public Web site at. Use the Ratings search box located in the leftcolumn.(New York Ratings Team)