(The following statement was released by the rating agency)Overview
-- Atlanta-based industrial distributor HD Supply Inc. is offering $750million of new senior unsecured notes and we expect it to use the proceeds toredeem a portion of its outstanding subordinated notes due 2015.
-- We are assigning a 'CCC+' issue-level rating to the proposed seniorunsecured notes with a recovery rating of '6'.
-- We are affirming our 'B' corporate credit rating on the company.
-- The stable outlook reflects our expectation that HD Supply's operatingperformance will sustain over the next year.
Rating ActionOn Oct. 9, 2012, Standard & Poor's Ratings Services affirmed all its ratingson HD Supply Inc., including its 'B' corporate credit rating. The outlook isstable. At the same time, we assigned a 'CCC+' issue-level rating and a '6'recovery rating to the company's proposed $750 million senior unsecured notesdue 2020. The '6' recovery rating indicates expectations for negligible (0% to10%) recovery in the event of default.
The ratings on privately owned HD Supply reflect the company's "satisfactory"business risk profile as a major industrial distributor of infrastructure andenergy, maintenance, repair and improvement, and specialty constructionproducts. The rating also reflects the company's "highly leveraged" financialrisk profile and the impact on its operating performance arising from theprotracted weakness in U.S. construction activity. However, the company'sbusiness-line diversity, leading market positions, and operational scale toweather the construction downturn partly offset these factors. Although weremain uncertain about the potential recovery in the construction cycle, HDSupply continues to expand its share of sales in the maintenance, repair, andoperations (MRO) and infrastructure markets, and reduce the effect of the weakconstruction markets on its near- to intermediate-term operating performance.Its capital structure has almost $6 billion of funded debt.
HD Supply's operations improved in the first half of the fiscal year,including a 12% increase in sales and a 29% increase in EBITDA, with goodperformance sequentially through the past fiscal year despite still-weak endmarkets. Although we expect certain end markets, including construction, toremain weak, HD Supply has improved its operations, and we expect furthermodest improvement in operations as the company maintains adequate liquidity.
We view HD Supply's business risk profile as satisfactory. The company hasleading market positions in its diverse lines of business and scale advantagesover its competitors, which continues to help it endure through a protractedweak period in U.S. residential and nonresidential construction. Residentialand nonresidential construction markets now only account for about one-thirdof the company's business, which constituted just greater than one-half of itsbusiness several years ago. We believe that HD Supply's business isstabilizing. The MRO and infrastructure markets now account for abouttwo-thirds of its business--these tend to be less cyclical than construction.The construction markets appear to be gradually improving from their lows butmay remain relatively weak compared with prior spending.
Despite some end-market pressures, HD Supply has generated positive cash flow,which we expect to continue, based on its business segments, geographicdiversity, industrial MRO business (which is less exposed to the housing andcommercial construction downturn), and its prior cost-cutting actions,including branch closings and personnel reductions. The company has seen animprovement in its industrial MRO business, which moves in tandem withimproved industrial demand. Over the longer term, we believe HD Supply'sleading business positions and scale of operations should provide competitiveadvantages. HD Supply's business is not very capital expenditure-intensive.
We assess the company's financial risk profile as highly leveraged, initiallybecause of its leveraged buyout in 2007 and subsequently because of the weakmarket conditions. However, some of the capital structure's features preserveliquidity despite the operating downturn that occurred, and its liquidity iswell above the minimal liquidity requirements (before testing its financialcovenants).
HD Supply recently refinanced its capital structure, and we view the extensionof maturities on its new debt as somewhat beneficial. Pro forma for the newunsecured note offering it will have some remaining subordinated debt maturingin 2015. The company had issued in April 2012 new payment-in-kind (PIK) seniornotes that are owned by the sponsors. We expect the company to have adequatesources of liquidity to meet its cash outlays. We do not expect the company tomake any large acquisitions. Although the refinancing essentially leaves totaldebt outstanding relatively unchanged, the capital structure will still havealmost $6 billion of funded debt.
We consider HD Supply's liquidity "adequate" to support the company'soperating needs. Our assessment of its liquidity currently meets or exceedsour tests for adequate liquidity and incorporates our following expectationsand assumptions:
-- We expect the company's sources of liquidity, including cash andfacility availability, to exceed its uses by 1.2x or more over the next 12 to18 months.
-- We expect net sources to remain positive, even if EBITDA declines morethan 15%.
-- We view HD Supply's relationships with banks as sound and believe thatit has a generally satisfactory standing in credit markets, given the recentrefinancing.
Liquidity sources currently include about $100 million in cash and about $1billion of availability on its $1.5 billion asset-based loan (ABL) revolvingcredit facility maturing in 2017. Although the borrowing-base advance limitscould decline, we do not expect to see any meaningful reductions in theavailability on the ABL--except when the company enters a seasonal buildup ofworking capital. We expect HD Supply to continue to have availability on thecredit facility above the minimum liquidity requirement. The facility has aspringing fixed-charge covenant if availability under the borrowing base fallsto less than $150 million.
The company has no significant debt maturities now until 2015. Unsecured debtincludes about $800 million in senior notes due 2020 held by the sponsors andpro forma about $1.1 billion in subordinated notes due in 2015 that arecurrently cash-pay. Private equity sponsors and affiliates also hold asubstantial amount of the remaining subordinated notes.
Recovery analysisFor the full recovery analysis, please see the recovery report on HD SupplyInc., to be published following this report on RatingsDirect.
The stable outlook reflects the modest but continual improvement in HDSupply's operating performance and EBITDA. Although there is still a risk thatthe currently weak end-market conditions will not improve measurably, webelieve that the company generates sufficient cash flow to service itsinterest payments. Its current adequate liquidity supports the rating, and ifits EBITDA to cash interest coverage falls to less than 1x, the company hasaccess to cash and revolving credit availability to meet any shortfalls thatmay occur in the near term.
Adequate liquidity and the lack of any sizable near-term debt maturitiesoffset significant uncertainty about operating profitability and cash flowover the next year. However, if, for example, EBITDA to cash interest coverageremains depressed, we see no prospects for improvement, and liquiditydiminishes, we could lower the ratings. We consider raising the ratings to beunlikely at this time because of the relatively weak, albeit improving,construction market conditions.
Related Criteria And Research
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18,2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Corporate Criteria: Analytical Methodology, April 15, 2008
Ratings ListRatings AffirmedHD Supply Inc.Corporate Credit Rating B/Stable/--Senior Secured Second Lien CCC+Recovery Rating 6Senior Secured First Lien B+Recovery Rating 2Senior Secured Revolver BB-Recovery Rating 1Senior Unsecured CCC+Recovery Rating 6Subordinated CCC+Recovery Rating 6New RatingHD Supply Inc.Senior Unsecured
$750 mil sr unsecd nts due 2020 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)