DBRS Comments on RONA Outlook

DBRS is today providing a summary of RONA inc.’s (RONA or the Company) recent operating performance in anticipation of the Company’s upcoming key spring and summer (Q2 & Q3) results.

RONA’s earnings profile remained under pressure for the third consecutive year in F2013 and into Q1 F2014 primarily because of an intense competitive environment, in addition to softer demand and harsh weather conditions in Eastern Canada where RONA is concentrated relative to the Canadian population. This largely offset the benefits of the Company’s restructuring efforts, which yielded $110 million in annualized cost savings. F2013 revenues declined 14.2% to approximately $4.2 billion (52 weeks versus 53 weeks the previous year) based primarily on the sale of the Company’s Commercial and Professional Market division, the planned closure of underperforming stores and negative same-store sales of 1.9%. EBITDA margins remained pressured, as cost savings achieved from the Company’s notable restructuring efforts were more than offset by weaker gross margins, driven by a highly competitive and promotional environment. As such, EBITDA, as calculated by DBRS, declined to approximately $138 million in F2013 from $171 million in F2012 and from $285 million in F2011. Operating performance in Q1 F2014 remained under pressure, as overall same-store sales declined 4% versus the same quarter the previous year, while EBITDA, as calculated by DBRS, increased primarily as a result of recent cost reduction initiatives.

RONA’s financial profile remained relatively stable in F2013 and into Q1 F2014, as lower levels of operating cash flow were largely offset by debt repayment using proceeds from the Company’s sale of its Commercial and Professional Market division. Cash flow from operations continued to track operating income, while capex declined notably as the Company continued to seek to conserve discretionary capital while investing in necessary information systems and store renovations. As a result of the decline in capex and despite a modest increase in total dividends, free cash flow before changes in working capital increased to $65 million in F2013 versus $59 million in F2012, a level that remains significantly lower than prior years. RONA used free cash flow and proceeds from the sale of its Commercial and Professional Market division to complete approximately $15.4 million of share repurchases and to repay debt. As a result, total balance sheet debt declined to approximately $175.4 million at year-end F2013 versus approximately $328 million in F2012, which combined with the decline in earnings to result in only a modest improvement in credit metrics (i.e., lease-adjusted debt-to-EBITDAR of 4.20 times (x) and lease-adjusted EBITDA coverage of 4.17x in F2013 versus 4.28x and 4.11x, respectively, in F2012). In Q1 F2014, the seasonal working capital requirements needed to build peak inventory levels for RONA’s spring and summer selling season resulted in an increase in balance sheet debt to approximately $337 million versus $175.4 million at year-end F2013 and $480 million at quarter-end Q1 F2013.

Going forward, DBRS believes that stabilization of RONA’s earnings profile will remain challenging in the near term, particularly as the Company will continue to face intense competition in an uncertain demand and housing market, highlighted by significant regional disparity. RONA’s typically high inventory balance and working capital position at the end of Q1 traditionally unwinds through the course of the year. DBRS believes that despite the recent decline in balance sheet debt, RONA’s credit risk profile will remain pressured until it displays sustainable growth in organic operating income and cash flow. DBRS will continue to monitor the Company’s operating performance through the disproportionately significant spring and summer periods (Q2 and Q3 F2014), which should provide a greater indication of the impact of RONA’s restructuring and repositioning efforts, key to whether the rating will stabilize in the current BB (high) rating category. Should RONA achieve stabilization of same-store sales and operating income, as well as a modest improvement in key credit metrics through the end of Q3 F2014, the rating outlook could stabilize. However, should RONA’s credit risk profile continue to display deterioration in same-store sales, operating income and key credit metrics through the end of Q3 F2014 (i.e., lease-adjusted debt-to-EBITDAR over 4.0x and lease-adjusted EBITDA coverage below 4.5x), a further downgrade to BB and Pfd-4 could 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.