(The following statement was released by the rating agency)
-- North American rent-to-own retailer Rent-A-Center has demonstrated thewillingness and ability to maintain credit ratios within levels indicative ofan "intermediate" financial risk profile.
-- We are raising the corporate credit rating to 'BB+' following ourupward revision of the company's financial risk profile to intermediate from"significant."
-- The stable outlook reflects our expectation for the company tomaintain credit ratios indicative of an intermediate financial risk profileand for the company's business risk profile to remain "fair" for at least thenext two years.
Rating ActionOn Oct. 11, 2012, Standard & Poor's Ratings Services raised its corporatecredit rating on Plano, Texas-based rent-to-own retailer Rent-A-Center Inc. to'BB+' from 'BB'. The outlook is stable.
At the same time, we raised our issue-level rating on the company's $300million 6.625% senior notes to 'BB' (one notch below the corporate creditrating) from 'BB-'. The recovery rating remains '5', indicating ourexpectation of modest (10% to 30%) recovery for noteholders in the event of apayment default or bankruptcy.
The rating action reflects Standard & Poor's expectation that the company hasboth the willingness and ability to maintain credit ratios indicative of anintermediate financial risk profile. We continue to view the company'sbusiness risk profile as fair.
The ratings on Rent-A-Center reflect Standard & Poor's analysis that thecompany's business risk profile will remain fair for at least the next twoyears, based on the company's meaningful presence in the U.S., ongoinggeographic expansion in Mexico, and recent channel expansion with RACAcceptance. We believe the company continues to lack a meaningfulinternational presence and it remains vulnerable to potentially increasingconsumer finance protection regulations in the U.S. We have revised thecompany's financial risk profile upward to intermediate from significant,principally because we forecast the company can sustain credit ratios withinthe range indicative of an intermediate financial risk profile. A key aspectof our forecast includes the assumption that financial policies will remainmoderate, meaning dividends, share repurchases, and potential acquisitionswill be funded with internally generated cash flows.
Our forecast for key credit ratios through the end of 2013 is as follows:
-- Lease-adjusted debt to EBITDA reaching 2.7x by the end of 2012 and2.6x by the end of 2013. As of June 30, 2012, we calculate leverage was 2.8x.
-- Funds from operations (FFO) to total debt reaching 39% by the end of2012 and 41% by the end of 2013. As of June 30, 2012, we calculate FFO tototal debt was 37%.
-- Debt to capital remaining at 46% at the end of 2012 and reaching 44%by the end of 2013. As of June 30, 2012, we calculate adjusted debt to capitalwas 46%.
Financial ratios indicative of an intermediate financial risk profile includeleverage between 2x and 3x, FFO to total debt between 30% and 45%, and debt tocapital between 35% and 45%.
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, and the unemployment rate remaining at or above 8%through late 2013 (see "U.S. Economic Forecast: He's Buying A Stairway ToHeaven," published Sept. 21, 2012, on RatingsDirect). Considering theseeconomic forecast items, our base-case forecast for the company's operatingperformance over the next two years is as follows:
-- Revenue growth in the high-single digit percent area, supported by RACAcceptance kiosk growth and international expansion in Mexico and, to a lesserextent, Canada.
-- Gross margin (excluding depreciation and amortization) declines byabout 50 basis points (bps) to about 17.5%, as the company further grows itslower-margin RAC Acceptance business and new stores in Mexico take time toreach their full potential.
-- Selling, general, and administrative (SG&A) expense growth no longeroutpaces revenue growth. This trend began in early 2012 and we expect it tocontinue, largely because the RAC Acceptance business requires less SG&A.
-- EBITDA margin declines versus the prior year and settles between 14%and 15%.
-- Debt reduction is limited to the contractual amortization of $25million per year under the term loan.
We view the company's financial risk policies as moderate. Significant debtreduction has occurred since 2006, though the rate of decline has slowed since2009 and we believe accelerated debt reduction is unlikely to resume for theforeseeable future. The company instituted a regular cash dividend during thethird quarter of 2010; we forecast cash dividends of about $40 million peryear. We believe the company will fund dividends, share repurchases, andpotential acquisitions with discretionary cash flows.
The company's primary focus on rent-to-own transactions is a key ratings riskfactor, especially with nearly all of its stores in the U.S. and the potentialfor U.S. regulation to hurt the rent-to-own retail business model. CurrentU.S. regulation focuses on strengthening consumer finance protectionregulations. Increased consumer finance protection regulations on rentalpurchase transactions could require the company to alter its businesspractices in a manner that impairs performance. For example, regulatorychanges could involve areas such as customer disclosure, rental terms, graceperiods, and pricing caps. At this time, it is difficult to quantify thepotential negative impact, though the lingering issue will constrain thebusiness risk profile for the foreseeable future.
We believe the company's RAC Acceptance business and international expansionwill be key growth drivers. Management estimates the company's RAC Acceptancekiosks will increase to 950 by the end of 2012. As of June 30, 2012, therewere 811 RAC Acceptance kiosks in service, up from 750 at the beginning of theyear. International expansion is likely to accelerate, in part because growthprospects in the U.S. rent-to-own industry are becoming more limited as theindustry matures. The company is focusing on Mexico--with 67 stores open as ofJune 30, 2012--and, to a lesser extent Canada, with 32 stores open as of June30, 2012. Establishing a meaningful presence outside the U.S. could be onecatalyst for a higher business risk profile, because it would reduce thecompany's vulnerability to changes in U.S. regulations and it would increasethe company's long-term growth prospects. We believe it will take considerabletime for the company to build a meaningful presence outside the U.S., giventhe rent-to-own industry's limited existence in most international markets.
We view the company's liquidity as "adequate." We expect the company's cashsources to exceed its cash uses over the next 24 months. Our assessment of thecompany's liquidity profile includes the following expectations, assumptions,and factors:
-- We forecast cash sources will exceed cash uses by more than 1.2x overthe next 12 months and will remain positive over the next 24 months.
-- We forecast net sources would remain positive, even if EBITDA were todecline 15%.
-- We forecast covenant cushion should remain sufficient.
-- Contractual debt amortization is manageable, at $25 million per year.
-- Debt maturities are favorable, with the revolving credit facility andterm loan due in 2016 and the senior notes due in 2020.
As of June 30, 2012, we calculate total liquidity was about $360 million,which included revolver availability of about $260 million. Over the pasteight quarters, average revolver availability was near $237 million, andfluctuated between $180 million and $280 million during this time. We expectthis pattern to continue.
We forecast free cash flow of about $100 million in 2012 and about $130million in 2013, which incorporates our expectation for capital expendituresto remain near $100 million per year. We assume share repurchases, dividends,and potential acquisitions consume the majority of discretionary cash flow.
Recovery analysisFor the complete recovery analysis, please see the recovery report onRent-A-Center Inc., to be published on RatingsDirect following this report.
The outlook is stable, reflecting our expectation for the company to maintaincredit ratios indicative of an intermediate financial risk profile and for thecompany's business risk profile to remain fair for at least the next two years.
We could lower our ratings if the company is unable, through weaker operatingperformance, or unwilling, through debt-financed share repurchases ordividends, to maintain credit ratios indicative of an intermediate financialrisk profile, which includes leverage sustained below 3x. Based onsecond-quarter financial results, an EBITDA decline of between 7% and 7.5% ora debt increase of nearly $100 million would cause leverage to increase to3.0x.
It is unlikely we will raise our ratings within the next two years, because webelieve the company's business risk profile will remain fair for that time.The company's ability to replicate the success of its U.S.-based businessmodel in other countries would improve its geographic diversity, which couldbe a catalyst for a higher business risk profile. We believe it will take aconsiderable amount of time for the company to build similar scale in aninternational market.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Ratings Criteria: Ratios And Adjustments, April 15,2008
Ratings ListRatings Raised; Recovery Rating UnchangedTo FromRent-A-Center Inc.Corporate Credit Rating BB+/Stable/-- BB/Stable/--Senior Unsecured BB BB-Recovery Rating 5 5
(Caryn Trokie, New York Ratings Unit)