NEW YORK--(BUSINESS WIRE)--Fitch Ratings has upgraded its ratings on Rite Aid Corporation (Rite Aid), including its Issuer Default Rating (IDR) to 'B' from 'B-'. The Rating Outlook is Stable. A complete list of ratings is provided at the end of this release.
KEY RATING DRIVERS:
The upgrades reflect the material improvement in the company's operating performance, credit metrics and liquidity profile over the past 24 months. Rite Aid's EBITDA increased to $1.3 billion in fiscal 2014 (year ended February 2014), after surpassing the $1 billion level for the first time in fiscal 2013. This improvement has been supported by the strong generic wave that boosted gross margins, as well as management's concerted efforts to stabilize its top-line through its loyalty card program and remodeling activity. Rite Aid has also pushed out major debt maturities to 2019 (with the exception of $64 million 8.5% convertible notes due in May 2015 and the revolver due 2018) and reduced its interest burden through a series of refinancings and debt reduction of approximately $600 million over the last 24 months.
Fitch expects EBITDA should be sustainable in the $1.2 billion to $1.3 billion range over the next 12 to 24 months, enabling the company to dedicate increased capex towards store remodels and some store relocation activity, as well devote free cash flow (FCF) to debt reduction. While Fitch expects gross margin to decline in fiscal 2015 (due to generics cycling through the first half of the year and pharmacy reimbursement pressure) and fiscal 2016, Fitch expects same store sales to grow in the 1% to 2% range on front-end same store sales growth of around 1%, prescription volume increase of 1%-2%, and some pharmacy inflation.
As a result, adjusted debt/EBITDAR and EBITDAR/interest plus rent are expected to be flat or improve modestly from 5.9x and 1.7x, respectively, at the end of fiscal 2014.
Rite Aid's operating metrics still significantly lag those of its largest and well-capitalized competitors, with average weekly prescriptions per store of approximately 1,240 (versus over 1,800 at CVS Caremark and Walgreen Co.) and an EBITDA margin of 5.2% (versus Walgreen's EBITDA margin at 6.7% and CVS's retail EBITDA margin at 11.3% pre-corporate costs).
In addition, Rite Aid has been unable to fully participate in the strong industry growth largely due to capital constraints. The Wellness+ loyalty card program and recent remodeling activity have helped the company stabilize its prescription volume and generate modest front-end growth. In fiscal 2014, front-end same-store sales in the Wellness Stores exceeded the non-Wellness Stores by 300 basis points, and script growth in the Wellness Stores exceeded the non-Wellness Stores by 1%, indicating the majority of the chain was still modestly negative.
The company expects to do 450 Wellness remodels in fiscal 2015, with 1,215 or 26% of its store base completed as of March 1, 2014. On a net basis, the total number of remodels on a base of approximately 4,600 units is expected to have a modest positive impact on overall sales and profitability. However, capital spending still remains below levels required to remain competitive, particularly given the lack of relocations and new store opening activity. As a result, the company's market share could remain stagnant or weaken over time, even in markets where it has a top-three position.
Strong Liquidity: Rite Aid had cash of $183 million and excess borrowing capacity of approximately $1.3 billion under its credit facility at March 1, 2014, net of $80 million in outstanding letters of credit. Rite Aid has maintained liquidity in the $950 million-$1.3 billion range for the past three years.
Fitch expects FCF, net of capex of $525 million, to be in the $500 million range in fiscal 2015, with a $150 million working capital benefit from its supply agreement with McKesson and in part due to lower interest expense as a result of the company's refinancing activities in 2013 and further debt paydown in 2014. The company expects to pay down the $270 million of 10.25% second-lien notes due 2019 when they become callable at 105 in the fall of this year. In fiscal 2016 and beyond, Fitch expects FCF to be in the $300 million range which should enable the company to modestly reduce debt overtime or invest a bit more on the Wellness remodels and store relocation activity.
The company has been actively refinancing its debt over the past year, pushing out the next major maturities to 2019 (with the exception of $64 million 8.5% convertible notes due in May 2015 and the revolver due 2018).
Positive: A positive rating action could result if Rite Aid sustains positive comparable store sales and EBITDA growth, and adjusted debt/EBITDAR improves to the low-to-mid 5.0x range. This is not anticipated at this time.
Negative: A negative rating action could result from deteriorating sales and profitability trends that takes EBITDA below $1 billion (as seen in fiscal 2010 through fiscal 2012) and leverage returns to over 7.0x.
The issue ratings shown below are derived from the IDR and the relevant Recovery Rating. Fitch's recovery analysis assumes a liquidation value under a distressed scenario of approximately $5.7 billion on inventory, receivables, owned real estate, and prescription files. The $1,795 million revolving credit facility, Tranche 6 term loan, and the $650 million senior secured notes due August 2020 have a first lien on the company's cash, accounts receivable, investment property, inventory, and script lists, and are guaranteed by Rite Aid's subsidiaries, giving them an outstanding recovery (91%-100%). The senior secured credit facility requires the company to maintain a minimum fixed charge coverage ratio of 1.0x only if availability on the revolving credit facility is less than $150 million. Rite Aid's fixed charge coverage ratio at 1.7x was above the minimum required amount. Fitch assumes that the revolver is drawn 80% for the purposes of the recovery analysis.
The Tranche 1 and Tranche 2 term loans and the 10.25% notes due October 2019 have a second lien on the same collateral as the revolver and term loans and are guaranteed by Rite Aid's subsidiaries. These are also expected to have outstanding recovery prospects. Given the amount of secured debt in the company's capital structure, the unsecured guaranteed notes are assumed to have average recovery prospects (31%-50%) and unsecured notes and convertible bonds are assumed to have poor recovery prospects (0%-10%) in a distressed scenario.
Fitch has upgraded Rite Aid Corporation's ratings as follows:
--IDR to 'B' from 'B-';
--Secured revolving credit facility and term loans to 'BB/RR1' from 'BB-/RR1';
--First- and second-lien senior secured notes to 'BB/RR1' from 'BB-/RR1';
--Guaranteed senior unsecured notes to 'B/RR4' from 'CCC+/RR5';
--Non-guaranteed senior unsecured notes to 'CCC+/RR6' from 'CCC/RR6'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology', (Aug. 5, 2013);
--'Recovery Ratings and Notching Criteria for Nonfinancial Corporate Issuers', (Nov. 19, 2013);
--'High-Yield Retail Checkout' (Jan. 28, 2014).
Applicable Criteria and Related Research:
High Yield Retail Checkout -- Amended
High-Yield Retail Checkout (Comprehensive Analysis of Major High-Yield Retailers)
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage