DBRS Changes Trend on RONA to Negative from Stable

DBRS has today changed the trend on the BBB Senior Unsecured Debt rating and Pfd-3 Preferred Shares rating of RONA inc. (RONA or the Company) to Negative from Stable. The rating action reflects DBRS’s concern that weak operating performance and a challenging consumer environment may result in RONA’s credit risk profile to deteriorate to a level that is no longer consistent with the current rating categories.

RONA’s revenue for the last 12 months (LTM) ending March 27, 2011, declined to $4,761 million from $4,782 million a year earlier despite the fact that the Company added five new stores and acquired Pierceys, TruServ Canada, Don Park and a number of smaller entities. The decline was due to continued weakness in same-store sales growth over the past year (up 0.9% in Q2 2010; down 2.3% in Q3 2010; down 6.4% in Q4 2010; and down 12.6% in Q1 2011). Weak same-store sales also had a significant negative impact on EBITDA margins, which declined to 6.48% for LTM ending March 27, 2011, from 7.16% a year earlier, leading to EBITDA of $308 million and $342 million, respectively. As such, lease-adjusted debt-to-EBITDAR increased to 2.90 times (x) from 2.55x a year earlier.

On June 25, 2010, DBRS confirmed RONA’s BBB rating with a Stable trend and stated that if the Company were to experience a decline in operating performance that resulted in lease adjusted debt-to-EBITDAR meaningfully greater than 2.65x, the rating or trend could come under pressure.

Although DBRS recognizes that debt levels are typically the highest at the end of the Company’s first quarter due to seasonal working capital requirements, we have become concerned that weak sales and profitability over the past year are more reflective of structural challenges rather than seasonality.

DBRS believes RONA would have to achieve a meaningful recovery in operating income and/or reduction in balance-sheet debt levels through the remainder of the year to re-establish lease-adjusted debt-to-EBITDAR in a range that is acceptable for the current ratings. This would likely require significant improvement in same-store and/or new-store sales performance, preservation of operating margins and significant capital-conserving measures, including prudence with respect to capex, working capital management, dividend payouts and debt-financed acquisitions, for the rest of the year, which DBRS believes may be difficult to achieve under current competitive and economic circumstances.

If RONA is successful in implementing a sustainable recovery, including improved operating performance (during the critical summer season in particular) and prudent capital management that result in a lease-adjusted debt-to-EBITDAR ratio closer to the 2.5x level by the end of the year, DBRS may consider changing the trend to Stable. On the other hand, a lack of improvement in sales, operating income and key credit metrics could result in a downgrade to the ratings before the end of the year.

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

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