(The following statement was released by the rating agency)
Oct 2 - Overview
-- Group 1 Automotive Inc.'s credit measures, in our opinion, have the potential for continued modest improvement in the year ahead.
-- We are revising our 'BB' rating outlook on Group 1 to positive from stable.
-- The positive outlook reflects the potential for an upgrade to 'BB+' within the next year, if the company's profitability and cash flow improve modestly, leverage remains near the current level or better, and the company's strategic and financial policies continue to balance growth with credit quality.
Rating Action On Oct. 2, 2012, Standard & Poor's Ratings Services revised its rating outlook on Houston-based automotive retailer Group 1 Automotive Inc.
to positive from stable. Our 'BB' corporate credit rating on Group 1, along with all related issue-level ratings on the company's debt, remains unchanged.
There is a one-in-three likelihood we could raise the ratings on Group 1 in the year ahead, if free operating cash flow (FOCF) to total debt remains at 20% or higher, leverage remains in the range of 3.0x to 3.5x, and debt to capital is 50% or less. Group 1's credit measures have shown steady improvement since the 2008-2009 recession because of improved vehicle and credit markets. We believe credit measures could improve modestly from this level in the year ahead because of Group 1's resilient business model, focused financial policy, and demonstrated operating expertise in recent years.
The ratings on Group 1 reflect its "fair" business risk profile and "significant" financial risk profile. Group 1 is one of several large consolidators in the highly competitive and very fragmented U.S. auto retailing industry.
Profitability, as measured by EBITDA margin which stood at 3.7% for the 12 months ended June 30, 2012, is thin, but has been stable in recent years. We expect Group 1 to maintain this margin in the year ahead because of expanding gross profit in its parts and service (P&S) business. Although we expect U.S. new vehicle sales growth in 2012 and 2013, new vehicle gross profit for the retailers remains in the single digits. We expect manageable capital spending and working capital needs, combined with tightly controlled SG&A, to lead to good cash generation. Group 1's FOCF is significant at 22% of lease-adjusted total debt, and we expect the company to generate free cash flow after capital spending of $150 million or better in 2012 and $170 million in 2013.
We view Group 1's business risk profile as fair because we expect its resilient business model, with its diverse revenue stream and variable cost structure, to support continued good profitability in the next two years. High-margin revenue generated by its P&S operations is relatively stable compared with vehicle sales which have volatile revenue and lower margin. We expect the P&S business to provide a revenue and margin cushion for Group 1, should there be a double-dip recession: This is what happened during the last recession, when same-store vehicle unit sales declined and showed margin pressure from weak pricing. Group 1's competitive position benefits from its established relationships with automakers, variety of brand offerings, and employment of corporate-wide automated systems to bring efficiencies to dealer management and customer service.
Group 1's significant financial risk profile reflects our belief that the company will generate free cash flow through at least 2013. We also expect Group 1 to maintain a balanced financial policy, using cash for acquisitions and capital spending that will to enable leverage to stay near current levels or lower. We expect the company to fund its acquisition activity using a combination of free cash flow and mortgage financing. Still, we also assume the company forgoes acquisitions if EBITDA and cash flow weaken.
Group 1 generates FOCF from its consistently high-margin parts and service (P&S) operations, which accounted for 44% of total gross profit in 2011, and tight focus on controlling SG&A as a percent of gross profits which stood about 75% at June 30, 2012.
Group 1's new-vehicle unit sales occur mostly in Texas and Oklahoma (44%), California (14%), and Massachusetts (11%), and economic conditions vary in these regions. Group 1 also had dealerships in the U.K. that accounted for 5% of new-vehicle retail units sold in 2011, and this market is much weaker than in the U.S. Group 1's new vehicle sales are heavily weighted toward three manufacturers-- Toyota Motor Corp., Honda Motor Co. Ltd., and Nissan Motor Co. Ltd.--which together accounted for 54% of Group 1's U.S. new-vehicle sales in 2011. This Japanese brand concentration has risen somewhat in 2012 as these brands recovered from the inventory shortfall precipitated by the 2011 earthquake and tsunami.
Group 1's liquidity is "adequate" under our criteria. We believe it has adequate sources of liquidity to cover near-term needs, even in the event of an unforeseen EBITDA decline. Our assessment of Group 1's liquidity profile incorporates the following expectations and assumptions:
-- We expect Group 1's sources of liquidity, including cash and credit facility availability, to exceed uses by 1.2x or more over the next 12 to 18 months.
-- We expect net sources of liquidity to remain positive, even if EBITDA declines more than 15%.
-- In our opinion, Group 1 could absorb a low-probability, high-impact market or operating shock, given its good conversion of EBITDA to cash flow.
On June 30, 2012, Group 1's liquidity sources included $9.5 million of cash on hand and $101.8 million available in a floorplan "offset" account (which we view as highly liquid). We expect the company to generate about $150 million of discretionary cash flow for 2012 and about $170 million in 2013.
Group 1 also has a revolving credit facility (expiring June 1, 2016), with 21 lenders, including four manufacturer-affiliated finance companies. We consider auto retailers' floorplan borrowings more akin to trade payables than to debt because of the borrowings' indefinite maturities, high loan-to-value ratios, and widespread availability, and because manufacturer subsidies largely offset borrowing costs.
The revolver, availability of which is limited based upon a borrowing base calculation within certain debt covenants, consists of two tranches:
-- $1.1 billion for vehicle inventory floorplan financing; as of Dec. 31, 2011, Group 1 had $101.8 million of immediately available funds of a total $315.5 million available.
-- $250 million for working capital, including acquisitions; as of Dec. 31, it had $225.7 million available under the acquisition line. Up to one-half of the acquisition line can be borrowed in either euros or pounds sterling.
The capacity under the two tranches can be redesignated within the overall $1.35 billion commitment, subject to the original limits of a minimum of $1.1 billion for the floorplan line and maximum of $250 million for the acquisition line. Group 1 was in compliance with the financial covenants under all its debt and lease agreements as of June 30, 2012, and, in our view, had a reasonable cushion for underperformance.
Group 1 has other credit facilities:
-- $150 million floorplan facility, due December 2012, with Ford Motor Credit Co. LLC (FMCC) to finance new-vehicle purchases from Ford Motor Co. We assume this will be rolled over. As of June 30, 2012, Group 1 had an outstanding balance of $103.3 million under the FMCC Facility, with an available floorplan capacity of $46.7 million.
-- Real estate (mortgage) term loan credit facility with Bank of America N.A. and other lenders, with the right to draw down a total of $83.4 million on fulfilling certain conditions. As of June 30, 2012, Group 1 had borrowings of $60.7 million under this facility, which expires December 2015.
-- U.K. floorplan credit facility with BMW Financial Services and Volkswagen Finance for the financing of new, used and rental vehicle inventories related to its U.K. operations. These facilities are evergreen arrangements that may be canceled with notice by either party. The outstanding borrowings stood at $71.5 million at June 30, 2012.
Group 1 pays a quarterly cash dividend to shareholders, which we estimate will total about $12.8 million in 2012, that we expect to be raised in line with earnings growth. The board of directors authorized a $50 million share repurchase program in July 2012, replacing the amount remaining from the August 2011 authorization.
We expect Group 1 to continue acquiring dealerships on an opportunistic basis. We expect these acquisitions to be funded with cash from operations, the revolving acquisition credit line, or mortgage debt. In 2012 to date, Group 1 has acquired 13 vehicle franchises in the U.S. and U.K. for which it expects to generate $535 million in annual revenues (equivalent to about 9% of 2011 revenues).
Group 1 expects to spend about $63 million on capital investments in 2012 and again in 2013, including $15 million for P&S expansion initiatives; we view this amount as consistent with the rating and recent spending levels.
Recovery analysis For the complete recovery analysis, please see Standard & Poor's recovery report on Group 1, to be published following this report on RatingsDirect.
Our positive rating outlook on Group 1 reflects a one-in-three likelihood we could raise the ratings on Group 1 in the year ahead. We would need to view Group 1's business profile as satisfactory, including the company's ability to sustain its improved profitability. In addition, we would have to expect FOCF to total debt to remain at 20% or higher, leverage to remain in the range of 3.0x to 3.5x, and debt to capital to be less than 50% for an upgrade to occur. For the 12 months ended June 30, 2012, Group 1's free operating cash was significant at 21% of lease-adjusted total debt, leverage stood at 3.2x, and debt to total capital was 50%. We expect Group 1's improved operating efficiencies, in combination with its diverse revenue stream and brand mix, to enable it to generate free cash flow after capital spending in 2012 and again in 2013. We would also need to believe that the company will employ a moderate financial policy that balances the expectations of shareholders with credit quality consistent with a higher rating.
Alternatively, we could revise the outlook to stable if a shift in financial policies leads to leverage exceeding 3.5x or FOCF to total debt falling below 15% in the year ahead. This could occur if aggressive debt-financed acquisitions led to higher debt, and if EBITDA for any 12 month period were to drop to $230 million or lower, leading to leverage of 3.5x. We could also lower the rating if the slow economic recovery reverses course, leading to declining revenues the company cannot offset with cost controls. We could also revise the outlook to stable if Group 1 uses a material amount of cash to fund a dividend payout to shareholders or to repurchase its common shares, though we believe this scenario is less likely.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- August U.S. Auto Sales Rise Above Standard & Poor's 2012 Full-Year Expectation, Sept. 5, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
Ratings Affirmed; Outlook Action
To From Group 1 Automotive Inc. Corporate Credit Rating BB/Positive/-- BB/Stable/--
Ratings Affirmed; Recovery Rating Unchanged
Senior Unsecured B+ Recovery Rating 6
Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at
. 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)