CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed its long-term Issuer Default Rating (IDR) on Staples, Inc. at 'BBB'. The Rating Outlook has been revised to Negative from Stable. As of Aug. 3, 2013, Staples had $2 billion of debt outstanding. A full list of rating actions is shown below.
Key Rating Drivers
The affirmation reflects Staples' leadership position in the mature retail and commercial office product supply industry, and diversified model by channel and customer, as well as ongoing debt repayment and solid free cash flow. The rating also reflects the company's soft sales and earnings trends that are due to the challenging macroeconomic environment, the secular trend from paper to digital, and significant operating challenges in Europe.
The Negative Outlook reflects the potential that current operating weakness could persist over the medium term, leading to further erosion in EBITDA, and resulting in a credit profile that is no longer consistent with the current rating.
Staples' operating profile is supported by its diverse customer base, as it sells to a balanced mix of large corporate customers, small businesses and consumers, and its significant online presence. It enjoys leading positions in its two largest segments - North American Stores and Online and North American Commercial, which accounted for 57% and 38%, respectively, of EBITDA in the 12 months ended Aug. 3, 2013. The international business, which is centered in Europe, faces significant challenges, and represents only 6% of EBITDA.
The company's recent trends have been soft, with sales down 3% in 2012 (on a 52-week) basis, and down 3.5% in 1Q'13 and 2% in 2Q'13. Within the North American Stores and Online segment, weak North American retail comps (down 2% in 2012 and in 1Q'13, and down 3% in 2Q'13), and the effect of store closures (31 in 2012 and 22 in 1H'13), were offset by 3% growth at Staples.com. The North American commercial segment has been relatively stable over time, and grew by 1.7% in 2012 and in Q1'13, and 1.3% in 2Q'13.
International sales, by contrast, were down a sharp 11.8% in 2012, 12.5% in 1Q'13, and 8.3% in 2Q'13, due to weakness in Europe and Australia. Fitch expects Staples' revenues will remain under pressure over the medium term, as benefits from its various growth initiatives may be offset by secular declines in the sales of office supplies and weak sales of technology products.
Staples' EBITDA margin declined to 8.5% in the 12 months ending Aug. 3, 2013 from 9.0% in 2011 as a result of operating weakness in Europe and investments to drive growth in the North American business. Fitch believes that weak sales trends could lead to another 75 basis points (bps) of EBITDA margin compression in 2013, causing EBITDA to decline to around $1.9 billion (adding back non-cash share-based compensation) from $2.1 billion in 2012.
Staples announced in September 2012 a set of initiatives to drive faster growth in its online and delivery businesses and improve same store sales while gradually reducing its retail footprint. Investments in price reductions at Staples.com and Quill.com, and other growth investments, will be financed in part by a $250 million, three-year cost reduction initiative. Management also plans to reduce retail square footage in North America by 15% by the end of 2015, through a combination of store closures, downsizings and relocations.
Fitch views these initiatives as positive steps, pressuring margins over the near term but potentially leading to faster online growth in the U.S., a more productive North American retail footprint, and gradually improved returns in the international business. However, the restructuring also underscores the challenges facing Staples' business over the next few years due to growth in online competition in the context of a weak economic environment that has already pressured sales growth and margins.
The pending merger of Office Depot and OfficeMax could improve the industry profile longer-term by eliminating one large player in the contract segment and reducing the amount of retail square footage through store closures.
Financial leverage (adjusted debt/EBITDAR) stood at 3.0x at Aug. 3, 2013, compared with 2.8x at year-end 2011, and is expected to remain in the high-2x range at fiscal year-end (January 2014)as declining EBITDA offsets the benefit of the expected repayment from cash of $876 million of notes maturing in January 2014. Fitch expects that further erosion in EBITDA could drive leverage back up to 3.0x at year-end 2014.
Staples has a strong liquidity position with cash and cash equivalents of $1.2 billion as of Aug. 3, 2013 and an unused $1 billion revolving credit facility expiring in May 2018. Free cash flow (FCF) after dividends was $576 million in 2012, and is expected to be around $600 million in 2013. Fitch expects that FCF will be directed toward share repurchases and the debt repayment described above, as well as smaller acquisitions. The rating does not contemplate any debt-financed share repurchase activity.
If weak sales and earnings trends persist, causing leverage to move to a level above 3.0x, Fitch would consider a one-notch downgrade.
If there is a stabilization of sales and operating margins, enabling leverage to remain below 3.0x, Fitch would consider revising the Rating Outlook to Stable.
Fitch has affirmed the following ratings as indicated:
--Long-term Issuer Default Rating (IDR) at 'BBB';
--Bank credit facility at 'BBB';
--Senior unsecured notes at 'BBB';
--Short-term IDR at 'F2';
--Commercial paper at 'F2'.
The Rating Outlook is Negative.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--Corporate Rating Methodology, Aug. 5, 2013;
--Analysis of U.S. Corporate Pensions, Aug. 5, 2011.
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
Analysis of U.S. Corporate Pensions