DBRS Downgrades Rona to BBB (low), Trend Remains Negative

DBRS has today downgraded the long-term rating of RONA inc. (Rona or the Company) to BBB (low) from BBB, maintaining the Negative trend. At the same time, DBRS has downgraded the Company’s Preferred Shares rating to Pfd-3 (low) from Pfd-3, also with a Negative trend.

On May 11, 2011, DBRS changed the trends on Rona’s ratings to Negative from Stable. This rating action reflected DBRS’s concern that weak operating performance and a challenging consumer environment could result in Rona’s credit risk profile deteriorating to a level that would no longer be considered consistent with the BBB rating category. 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 and prudent capital management that would take lease-adjusted debt-to-EBITDAR closer to the 2.5x mark by the end of the year, it would consider changing the trend to Stable.

Subsequent to that statement, 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. Yesterday, Rona released its Q3 2011 results, which delivered same-store sales growth of -5.1%. Overall revenue increased by 2.1% (due to the inclusion of acquisitions and new store openings), resulting in EBITDA of $105.4 million, an increase of 1.7% year-over-year. As such, combined with a moderate increase in debt from the previous year, lease-adjusted debt-to-EBITDAR for the last twelve months ended Q3 2011 increased to 3.1x.

Furthermore, on November 3, 2011, DBRS commented on Rona’s announced offer to purchase up to $200 million of aggregate principal amount of its 5.40% unsecured debentures due October 20, 2016. DBRS stated that although the proposed debt repurchase could reduce Rona’s gross balance sheet debt 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. DBRS therefore reiterated its view that Rona would need to demonstrate strong signs of recovery in sales and operating income to stabilize its credit risk profile.

The deteriorating operating performance and weakened credit metrics result in a credit risk profile that is no longer consistent with a BBB rating. In terms of outlook, DBRS has maintained the Negative trend on the ratings as we believe meaningful recovery will remain challenging, since Rona is expected to continue facing intense competition in a highly promotional-based, consumer-challenged environment. The Company expects to generate some cost savings, which may help offset investment in pricing. Nevertheless, DBRS expects that any significant improvement in performance will be difficult to realize without same-store sales and margin stabilization over the near term.

If the Company’s plans and performance lead to signs of stabilization in same-store sales, operating income and key credit metrics (lease-adjusted debt-to-EBITDAR of approximately 3.0x) over the next year, the ratings outlook could stabilize. However, a continued and meaningful decline in same-store sales, operating income and key credit metrics over the course of 2012 could result in a downgrade to BB (high).

Notes:
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.