DBRS Confirms RONA at BBB (low) and Pfd-3 (low), Trend Negative

DBRS has today confirmed the Senior Unsecured Debt and Preferred Shares ratings of RONA inc. (RONA or the Company) at BBB (low) and Pfd-3 (low), respectively, with the trend remaining Negative. The rating reflects RONA’s recently announced New Realities, New Solutions plan, as well as the change in capital structure undertaken with the early repurchase of debentures in late F2011. The Negative trend remains in view of the continued uncertainty with respect to RONA’s ability to improve its operating performance in a challenging consumer and competitive environment.

Net sales of approximately $4.8 billion were flat in F2011, as a result of a 7.3% decline in same-store sales, which was offset by acquisitions and new store openings. Same-store sales performance continued to be negatively affected by intense competition and a challenging consumer environment. EBITDA margins came under pressure, declining to 6.0% from 6.4% the previous year due to the increasing use of promotions in response to the competitive environment combined with higher input costs (i.e., transportation and fuel) and lower-margin acquisitions. As a result, EBITDA declined by approximately 7.6% to $285 million. Nearing the end of F2011, RONA announced its New Realities, New Solutions plan, which aims to revitalize corporate stores and redeploy the Company’s asset base, shifting toward proximity stores that offer higher levels of service and seek to capitalize on shifting consumer expectations. Restructuring costs associated with the plan (approximately $71 million in F2011) are expected to be partially funded through the sale of non-strategic assets and the Company is expecting that results will begin to be visible by the end of F2012. Net sales in Q1 F2012 improved to $934.9 million from about $918.2 million in the same quarter the previous year, based on higher distribution sales, expansion in the professional division, and a moderation in same-store-sales decline of -0.8%. EBITDA margins improved modestly in Q1 F2012. As such, RONA’s slowest quarter annually – the first quarter – saw an improvement in EBITDA to $4.3 million from $1.6 million a year earlier.

In terms of financial profile, cash flow from operations continued to track operating income, declining significantly to approximately $185.3 million in F2011. Capex declined to $109.4 million from $146 million a year earlier, as the Company sought to exercise more discipline in terms of allocating capital. Dividends increased as RONA began issuing semi-annual dividends on its common shares, along with the dividends on its preferred shares issued in F2011. Total dividends paid in F2011 amounted to $27.6 million. As such, free cash flow before changes in working capital was nearing the $50 million level. On November 3, 2011, RONA announced its intention to recalibrate its capital structure by repurchasing a portion of its outstanding debentures not due until 2016. At the completion of the offer, the Company had repurchased $283 million of the nearly $400 million outstanding. This resulted in an improvement in lease-adjusted debt-to-EBITDAR to 2.54 times (x) at year-end F2011 from 2.80x a year earlier. Due to the lack of cash on hand during Q1 F2012 after the repurchase of the debentures, RONA used its credit facility to fund its inventory build-up in advance of the important spring and summer seasons. As such, balance-sheet debt increased, resulting in lease-adjusted debt-to-EBITDAR of 2.68x at quarter-end.

Going forward, DBRS believes that with its renewed focus, the Company has the potential to stabilize earnings through slow improvements in same-store sales despite an ongoing challenging environment. Margins are expected to remain relatively stable but could be pressured should RONA invest in pricing through greater promotional activity to drive the top line. As such, DBRS believes that EBITDA should grow in the low single digits through the remainder of F2012, but material improvements will not be without significant challenges. Operating performance through the second and third quarters, traditionally RONA’s most important quarters, will be significant indicators of its stability going forward.

In terms of financial profile, DBRS believes that cash flow from operations should improve in line with operating performance, while capex and dividends should remain relatively stable. As such, free cash flow before changes in working capital could improve to the $65 million range. As is typical, RONA’s high inventory balance and working capital position at the end of Q1 should unwind through the course of the year, which DBRS expects will result in a commensurate reduction in the amount drawn on RONA’s credit facility. DBRS therefore expects balance sheet debt to decline, which, combined with some improvement in operating income, should result in a modest improvement in key credit metrics (i.e., lease-adjusted debt-to-EBITDAR), which could in turn lead to the rating trend stabilizing. Should RONA, however, not be successful in improving its credit metrics as a result of continued weakness in operating income and/or more aggressive-than-expected financial management, a downgrade would likely result.

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.