CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'B' Issuer Default Rating (IDR) and 'BB/RR1' secured bank facility rating of DineEquity, Inc. (NYSE: DIN). Fitch has also upgraded the company's 9.5% senior unsecured notes maturing Oct. 30, 2018 to 'B+/RR3' from 'B/RR4' due to improved recovery prospects. The Rating Outlook is Stable.
At March 31, 2011, DineEquity had approximately $1.86 billion of total debt.
DineEquity's ratings reflect its high financial leverage but balances that against its consistent free cash flow (FCF; defined as cash flow from operations less capital expenditures and dividends) generation and its on-going financial strategy. DineEquity continues to utilize FCF, which has averaged roughly $100 million annually, and refranchising proceeds to reduce debt. The ratings also consider the competitive position of the company's 2,009 Applebee's Neighborhood Grill & Bar restaurants (Applebee's) and 1,504 IHOP Restaurants (IHOP) at March 31, 2011.
DineEquity's credit profile benefits from the stable source of royalty-based revenue and the high margins provided by its franchised business model. At March 31, 2011, on a combined basis, 92% of DineEquity's restaurants were operated by franchisees. Fitch believes the company's relationship with its franchisees is constructive but is mindful of potential risks associated with a highly franchised model. During 2010, 28% or $376.7 million of DineEquity's $1.3 billion of corporate revenue came from its franchise operations which had an operating margin of 72.4%.
Producing profitable sales and traffic growth, improving margins of company restaurant operations, and refranchising remain core elements of DineEquity's operating strategy. Fitch believes the company is making good progress towards its goals. Same-store sales (SSS) performance at Applebee's has been positive for three consecutive quarters and was 3.9% during the first quarter ended March 31, 2011. Although IHOP's SSS declined 2.7% during the most recent quarter, the company has efforts in place to drive sales and regain momentum. Fitch believes DineEquity's guidance of 2% to 4% and (2%) to 1% SSS growth at Applebee's and IHOP, respectively are achievable. DineEquity's efforts around value and menu innovation at both these brands should help drive traffic. Examples at Applebee's include periodic updates to its 2 for $20 offerings and Great Tasting and Under 550 Calorie items while examples at IHOP include on-going breakfast-related promotions and its Simple & Fit under 600 calorie menu options.
Restaurant margins for company-operated Applebee's restaurants experienced 50 basis points of year-over-year improvement to 15.3% at March 31, 2011. Margins are up substantially from the 10.7% level at Dec. 31, 2007. The company benefited from lower food cost and labor efficiencies over the past two years but expects food cost inflation of around 1.5% at Applebee's and 3% at IHOP during 2011. Fitch expects pricing to partially offset these incremental costs in 2011.
DineEquity has approximately 220 company-operated Applebee's restaurants left to refranchise, after selling 65 units during the first quarter ended March 31, 2011. While the timing of transactions remains uncertain, the pace of deals has definitely picked up over the past year. Fitch believes the company can achieve its goal of being a 98% franchised system within the next 2-3 years.
Recovery Ratings and Upgrade on Senior Unsecured Debt:
At March 31, 2011, 40% of DineEquity's $1.86 billion of total debt consisted of a secured bank term loan. While an event of default is not anticipated, the 'RR1' rating on this debt incorporates Fitch's view that recovery prospects for this obligation are outstanding and would exceed 90% even in a distressed situation.
Due to the repayment of $110 million of its secured term loan and $32.2 million of its 9.5% unsecured notes during the first quarter ended March 31, 2011, recovery prospects for the company's unsecured debt have improved. The upgrade to 'B+/RR3' from 'B/RR4' for these obligations reflects that improvement. The 'RR3' rating denotes Fitch's view that recovery would be good at between 51% - 70% if there was a restructuring event.
Credit Statistics and Key Rating Drivers:
For the latest 12 month (LTM) period ended March 31, 2011, total adjusted debt-to-operating EBITDAR (defined as total debt plus eight times gross rent expense-to-operating earnings before interest, taxes, depreciation, amortization and gross rents) was 6.2 times (x) and total debt-to-operating EBITDA was 5.7x. Operating EBITDAR-to-gross interest expense plus rents was 1.6x while operating EBITDA-to-gross interest expense was 2.0x. LTM FCF, as calculated by Fitch, was $148 million.
Fitch believes DineEquity's credit statistics are appropriate for the rating category but expects improvement over the next 12-24 months as the company continues to refranchise and applies sale proceeds and the majority of its FCF to debt reduction. Total adjusted debt-to-operating EBITDAR in the 5.5x range along with consistent meaningful FCF generation could lead to positive rating actions. Fitch believes leverage can fall to this level by the end of 2012 and that FCF will remain in the $100 million range annually. Interest coverage should benefit from the repricing of the company's term loan on Feb. 25, 2011. The LIBOR-based margin was reduced to 3% from 4.5% with a floor of 1.25% versus 1.5% previously. The company expects annual interest savings of about $13 million as a result of the refinancing.
Liquidity, Debt Maturities and Covenants:
DineEquity's positive FCF is supplemented by an undrawn $75 million revolver which expires Oct. 19, 2015 and $50 million of cash at March 31, 2011. The company's liquidity is viewed as adequate given the minimal cash needs of a highly franchised business. Near-term maturities are limited, as the remaining $734 million balance on its term loan and $793 million of 9.5% senior unsecured notes are not due until Oct. 19, 2017 and Oct. 30, 2018, respectively.
Financial covenants in DineEquity's secured credit facility include a maximum consolidated leverage ratio covenant (defined as total indebtedness minus no more than $75 million of cash-to-EBITDA) of 7.5x beginning in 2011, stepping down to 6.0x by 2017. Given that the company's leverage as defined by this covenant was approximately 5.4x at March 31, 2011, DineEquity has approximately 28% of EBITDA cushion under this covenant. DineEquity's guaranteed senior unsecured notes do not have financial covenants but contain a Negative Pledge clause that requires equal and ratable security if non-permitted secured debt is incurred and have a change of control put option at 101% of principal plus accrued and unpaid interest.
Fitch's ratings on DineEquity, Inc. are as follows:
DineEquity, Inc. (Parent)
--Long-term Issuer Default Rating (IDR) 'B';
--Bank credit facility 'BB/RR1';
--Senior unsecured debt at 'B+/RR3'.
Additional information is available at 'www.fitchratings.com'. The ratings above have been initiated by Fitch as a service to investors. The issuer did not participate in the rating process other than through the medium of its public disclosure.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 13, 2010).
--'2011 Outlook: Restaurants - Positive Operating and Credit Trends, but Modest Sales Growth and Food Inflation Anticipated for the Industry' (Nov. 16, 2010).
Applicable Criteria and Related Research:
Corporate Rating Methodology
2011 Outlook: Restaurants