DBRS Comments on RONA Following Equity Issue and Q1 Results

DBRS notes that RONA, Inc. (RONA or the Company) has announced that it has entered into an agreement with a syndicate of underwriters to sell common shares for aggregate gross proceeds of $150 million. In addition, the Company has agreed to grant an option to the underwriters to purchase additional shares that could result in total gross proceeds of $172.5 million to RONA if the option is exercised.

RONA also released Q1 2009 results yesterday – earnings were basically in line with expectations, but top-line results (revenue -7% year-over-year, same-store sales -8.5%) were less than DBRS expectations. Although Q1 is a small quarter for RONA, the latest results have led DBRS to moderately revise its 2009 forecast for the Company. DBRS believes same-store sales for the full year could now actually decline to the -5% to -7% range (versus DBRS’s previous estimate of -3% to -5%). In terms of EBITDA, DBRS believes 2009 will likely be close to the low end of its $325 million to $350 million estimate.

RONA’s equity issue announcement firms up DBRS’s view of the Company’s credit risk profile. On December 15, 2008, DBRS confirmed RONA’s Senior Unsecured Debt rating at BBB with a Stable trend. The action was 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. At that time, DBRS believed the economic environment in Canada would continue to deteriorate and remain difficult for most of 2009. Weakness in the housing and home improvement sectors would continue to pressure RONA’s same-store sales and operating income, despite the Company’s focus on dealer recruitment and efficiency improvement initiatives. DBRS believed that EBITDA of $325 million to $350 million in 2009, combined with lower capex and our expectation for the company to refrain from share repurchases and acquisitions (of meaningful size) would 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). As such, DBRS forecast that RONA would 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.

DBRS now believes that RONA may be able to improve credit metrics slightly in 2009 with proceeds from the announced equity issue being used primarily for debt reduction. This view is further bolstered with the announcement of even further cost cutting and capital conservation initiatives and DBRS’s belief that RONA’s working capital position will benefit from gradually reduced inventory levels through 2009.

DBRS takes comfort in RONA’s follow through of its commitment to prudent operational and financial management through the most difficult part of the economic cycle. The Company undertook this equity issue despite that fact its liquidity remains healthy with positive free cash flow, a $650 million revolving credit facility that is committed until October 2012, and $400 million of debentures that do not mature until 2016.

DBRS continues to believe that 2009 should represent the bottom of the cycle – as we expect the economy to begin to recover by 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.

Notes:
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.