DBRS Confirms Rona at BBB

DBRS has today confirmed the Senior Unsecured Debt rating of RONA Inc. (RONA or the Company) at BBB with a Stable trend. The action is based on DBRS’s view that management of RONA is taking and will continue to take appropriate measures to protect the credit risk profile of the Company within the context of a difficult operating environment.

In 2008, RONA responded to a weakening economy and slowing home-improvement sector by scaling back the pace of new store openings (six versus ten in 2007), refraining from material acquisitions, focusing on the recruitment of new dealers and implementing a new efficiency improvement program (PEP – productivity, efficiency and profitability).

These actions enabled the Company to increase free cash flow and reduce debt (by an estimated $125 million by the end of 2008), despite moderately negative same-store sales and lower EBITDA. DBRS estimates RONA will generate EBITDA of approximately $375 million in 2008 (versus $400 million in 2007) and end the year with approximately $530 million of balance sheet debt. This should result in lease-adjusted debt-to-EBITDAR of 2.65x for the full year 2008 (using a 6-times multiple to capitalize operating lease expense, versus 2.61x for 2007).

DBRS believes the economic environment in Canada will continue to deteriorate and remain difficult for most of 2009. Weakness in the housing and home improvement sectors will continue to pressure RONA’s same-store sales and operating income, despite the Company’s focus on dealer recruitment and efficiency improvement initiatives. DBRS forecasts that RONA’s EBITDA will decline to $325 million to $350 million in 2009 based on $200 million of retail sales from new affiliate dealers and our estimate for same-store sales to decline to the -3% to -5% range.

That said, DBRS believes RONA will be able to protect its credit risk profile based on its strong free cash flow generating capacity and its commitment to further debt reduction. DBRS estimates that EBITDA of $325 million to $350 million in 2009 would likely convert to cash flow from operations before changes in working capital of $225 million to $250 million. DBRS expects that RONA will reduce new store openings to four for 2009, and two for 2010, resulting in a decline in capital expenditures to approximately $150 million in 2009 (versus $234 million in 2007, and approximately $200 million estimated for 2008). DBRS also believes RONA’s working capital position has the potential to benefit from gradually reduced inventory levels through 2009.

These factors, combined with our expectation for the company to refrain from share repurchases and acquisitions (of meaningful size) should enable the Company to generate free cash flow before any benefit from changes in working capital of approximately $75 million to $100 million (RONA does not pay a dividend). RONA should be able to keep key credit metrics fairly level in 2009 (i.e., lease-adjusted debt-to-EBITDAR at approximately 2.65x) with the application of this free cash flow to debt reduction. In terms of liquidity, RONA remains very healthy with positive free cash flow, a $650 million revolving credit facility that is committed until October 2012 and $400 million of debentures maturing in 2016.

DBRS believes 2009 should represent the bottom of the cycle – as we expect the economy to begin to recover toward the end of the year – and RONA’s good brand name/market position, agile business model and strong free cash flow/liquidity should keep the Company well positioned to recover as the economic climate improves. If the Company performs as we expect and follows through with debt reduction, the trend should remain Stable. Should credit metrics trend away from levels appropriate for the current rating category (lease-adjusted debt-to-EBITDAR of 2.3x to 2.7x) based on weaker than expected operating performance, inadequate debt reduction and/or a deeper/longer than expected economic downturn (that erodes the Company’s capacity to manage its credit metrics), the rating and/or trend would be pressured.

Note:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Merchandisers, which can be found on the DBRS website under Methodologies.

This is a Corporate Rating.