NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a 'B/RR4' rating (with recovery prospects of 31% to 50%) to Rite Aid Corporation's (Rite Aid) new $1.8 billion 6.125% guaranteed senior unsecured notes due April 1, 2023, and has concurrently downgraded $1.7 billion of its existing guaranteed senior unsecured notes to 'B/RR4' from 'B+/RR3'.
The notes will be used to finance Rite Aid's $2 billion acquisition of Envision Pharmaceutical Services (EnvisionRx), an independent full-service pharmacy benefit management (PBM) company which is expected to close by September 2015, subject to regulatory approvals and other customary closing conditions. If the acquisition is not completed, the new notes could be used to redeem existing debt and have special optional redemption features.
The new notes are fully and unconditionally guaranteed, jointly and severally, on an unsubordinated basis, by all of its subsidiaries that guarantee its obligations under its senior secured credit facility (the 'Senior Credit Facility'), the Tranche 1 Term Loan, the Tranche 2 Term Loan, and 8.00% notes due 2020, and existing notes ($902 million 9.25% Notes due March 2020 and $810 million 6.75% senior notes due June 2021) and, upon consummation of the acquisition, by EnvisionRx and certain of its domestic subsidiaries other than Envision Insurance Company. The guarantees are unsecured.
Fitch has also affirmed the following ratings:
Rite Aid Corporation
--IDR at 'B';
--Secured revolving credit facility and term loans at 'BB/RR1';
--First and second lien senior secured notes at 'BB/RR1';
--Non-guaranteed senior unsecured notes at 'CCC+/RR6'
The Rating Outlook is Positive.
KEY RATING DRIVERS
Fitch Ratings views Rite Aid's February 2015 announcement that it will acquire EnvisionRx, an independent full-service pharmacy benefit management (PBM) company, as a positive move as it will enable the company to expand its distribution channels by getting a foothold in the specialty and mail-order channels. The acquisition is supported by Rite Aid's ability improved credit metrics and cash flow over three years, enabling it to start making investments that will help strengthen its competitive positioning over the medium-longer term in the complex and evolving healthcare landscape where there is increased demand for an integrated health and wellness offering.
The transaction is valued at approximately $2 billion, which includes the value of an expected future tax benefit of $275 million and is being financed by the $1.8 billion note issuance and $200 million in Rite Aid stock, or approximately 27.9 million shares. Proforma for the transaction, Rite Aid's adjusted leverage is expected to increase to 6.2x from 5.9x in fiscal 2015 (February 2015) versus Fitch's prior expectations that it would trend towards the mid-5x range over the next 24 months. However, Fitch expects leverage will get back to below 6x in 24 months assuming FCF is deployed towards debt reduction post the transaction.
EnvisionRx is a national, full-service pharmacy benefit management (PBM) company with projected 2015 calendar year revenues of approximately $5 billion and projected 2015 calendar year EBITDA in a range of $150 to $160 million. Fitch expects EBITDA from this business could potentially double over the next five years on additional contract wins and growth in its specialty business (from a low base currently). The transaction is expected to be accretive to Rite Aid's earnings in the first full year following the closing of the transaction.
Fitch expects Rite Aid's EBITDA before the contribution from EnvisionRx to be sustainable at $1.3 billion over the intermediate term, enabling the company to dedicate increased capex toward store remodels and some store relocation activity, and to devote FCF to debt reduction. While Fitch expects gross margin to decline in the 20 bps- 30 bps range annually, due to ongoing pharmacy reimbursement rate cuts that will put some pressure on the current LTM EBITDA margin of 5.1%, Fitch expects same-store sales to grow at 2%-3% over the next 24 months, resulting in relatively flat EBITDA levels. The same-store sales projection is based on front-end same-store sales of 1%, prescription volume growth of 1.5% - 2.0% and some pharmacy inflation.
Rite Aid's operating metrics still significantly lag its larger peers, with average weekly prescriptions per store of 1,260 and retail EBITDA margin of 5.1%, versus 6.7% for Walgreen Co. and 11.8% for CVS Caremark's (CVS) retail business, pre corporate costs. However, its Wellness+ loyalty card program and recent remodeling activity have helped stabilize prescription volume and have resulted in modest front-end growth. In addition, the acquisition will now provide some exposure to other distribution channels and Fitch expects Rite Aid's market share to remain relatively stable over the intermediate term.
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 approximately $350 million after taking into account $70 million related to the acquisition of Health Dialog and RediClinic in fiscal 2015. Fitch expects FCF to be in the $300 million range in fiscal 2016 and $200 million thereafter. Fitch expects the acquisition to be FCF neutral in the first year (with project interest expense of $130 million and capex of $20 million largely offsetting the $150 million to $160 million projected 2015 EBITDA) but should be FCF positive thereafter in line with EBITDA growth. This should support further debt reduction, barring significant incremental capex spend or investments in the business, and bring back leverage from 6.2x post acquisition to under 6x over the next 24 months.
KEY ASSUMPTIONS
--Rite Aid's EBITDA before the contribution from EnvisionRx is expected to be sustainable at $1.3 billion over the intermediate term, with same store sales growth of 2% to 3%.
--EnvisionRx is projected to have 2015 calendar year revenues of approximately $5 billion and EBITDA in a range of $150 to $160 million. Fitch expects EBITDA from this business could potentially double over the next five years on additional contract wins and growth in its specialty business (from a low base currently).
--Fitch expects FCF to be in the $300 million range in fiscal 2016 and $200 million thereafter. The acquisition is expected to be FCF neutral in the first year but should be FCF positive thereafter in line with EBITDA growth. This should support further debt reduction, barring significant incremental capex spend or investments in the business, and bring back leverage from 6.2x post acquisition to under 6x over the next 24 months.
RECOVERY CONSIDERATIONS
The issue ratings shown are derived from the IDR and the relevant Recovery Rating. Fitch's recovery analysis assumes distressed enterprise value of approximately $6.0 billion on Rite Aid's existing inventory, receivables, prescription files and owned real estate.
The $3.0 billion revolving credit facility due January 2020 (or up to $3.7 billion when the company repays its 8.00% Senior Secured Notes due 2020 in full) 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. This gives them outstanding recovery prospects (91%-100%) that support their 'BB/RR1' rating. 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 $175 million at any time.
The $970 million in Tranche 1 and Tranche 2 term loans 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 and are rated 'BB/RR1'.
The existing $1.7 billion and the new $1.8 billion guaranteed unsecured notes are expected to have average recovery prospects (31%-50%) and are therefore rated 'B/RR4'. The approximately $500 million unsecured non-guaranteed notes are assumed to have poor recovery prospects (0%-10%) in a distressed scenario.
RATING SENSITIVITIES
Positive Rating Action: A positive rating action could result if Rite Aid sustains positive comparable store sales and EBITDA in the $1.5 billion range or better, enabling to company to further reduce debt and reduce adjusted debt/EBITDAR towards the mid-5.0x range.
Negative Rating Action: A negative rating action could result from deteriorating sales and profitability trends that take leading to negative FCF and leverage to over 7.0x.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 28, 2014);
--'Recovery Ratings and Notching Criteria for Nonfinancial Corporate Issuers' (Nov. 19, 2014).
Applicable Criteria and Related Research:
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=813588
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=981754
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