DBRS Comments on RONA Following Debentures Buyback

DBRS notes that RONA inc. (RONA or the Company) today announced that it has offered to purchase for cash, by way of two successive offers, up to $200 million of the aggregate principal amount of its 5.40% unsecured debentures due October 20, 2016. RONA stated that it believes the action will allow it to optimize its capital structure and add flexibility to its available financial resources.

On May 11, 2011, DBRS revised RONA’s trend to Negative from Stable. That rating action reflected DBRS’s concern that weak operating performance and a challenging consumer environment may result in RONA’s credit risk profile deteriorating to a level that is no longer consistent with the current rating categories. DBRS’s concern was highlighted by continued weakness in same-store sales growth and the negative impact this was having on operating margins and income. At that time (end of Q1 2011), lease-adjusted debt-to-EBITDAR had increased to 2.82 times (x) from 2.55x a year earlier. DBRS stated that if RONA was successful in implementing a sustainable recovery, including improved operating performance (during the critical summer season, in particular) and prudent capital management that results in a lease-adjusted debt-to-EBITDAR ratio closer to the 2.5x level by the end of the year, it 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.

Since then, RONA released its Q2 2011 results, which delivered same-store sales growth of -9.6%, overall revenue decline of -2.4% and EBITDA of $90 million (versus $133 million year-over-year) as the Company continued to engage in heavy promotional activity to spur growth. This performance resulted in the last 12 months lease-adjusted gross debt-to-EBITDAR of 3.1x.

Although the proposed debt repurchase could reduce RONA’s gross balance sheet by $200 million, the Company’s leverage remains unchanged on a net debt basis. In addition, RONA would have to rely on its bank facilities for liquidity going forward as it would have utilized its complete cash balance. As such, DBRS’s view that RONA needs to demonstrate strong signs of recovery in sales and operating income to stabilize its credit risk profile remains primary. Therefore, this action will not be sufficient to offset continued weakness in operating performance.

DBRS maintains its view that stabilization will require significant improvement in sales, operating income and significant capital conserving measures – including prudence with regards to capex, working capital management, dividend payouts, share repurchases and debt-financed acquisitions – for an extended period. Lack of improvement in sales, operating income, and key credit metrics in the near term could result in a ratings downgrade.

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

The applicable methodology is Rating Companies in the Merchandising Industry, which can be found on our website under Methodologies.