OREANDA-NEWS. Fitch Places BUT on RWP; Upgrades Senior Notes to 'B+'/'RR2' Paris/London Fitch Ratings has placed Decomeubles Partners SAS's (BUT) Long-Term Issuer Default Rating (IDR) of 'B-' on Rating Watch Positive (RWP). Simultaneously the agency has upgraded BUT SAS's EUR246m senior secured notes' rating to 'B+'/'RR2'/79% from 'B'/'RR3'/68% on the basis of revised stronger recovery expectations upon default and placed it on RWP.

The RWP reflects our expectations that we could upgrade BUT's IDR should the current capital structure stay in place after the announced sale of the group to a new consortium (to be completed in 2H16), providing a level of leverage and degree of financial flexibility compatible with a 'B' rating. However a more aggressive debt financing structure could result in the IDR being affirmed at 'B-'.

The RWP also reflects BUT's strengthened business profile, supported by an enhanced business model which provides the group with higher and more resilient profitability. Fitch also factors in BUT's enhanced free cash flow (FCF) generation capacity (regardless of capital structure considerations), supported by higher profitability and strongly improved working capital management.

KEY RATING DRIVERS

Sales Announcement, Leverage Impact

BUT has recently stated that it has granted exclusivity to a consortium set up between CD&R and WM Holding, an investment company associated with the XXL Lutz group based on a binding and irrevocable offer to acquire 100% of BUT's share capital.

Completion of the transaction is still subject to various steps and currently there is little clarity on the financing structure. However the current EUR246m senior secured notes carry a portable clause on a change of control event which does not allow the put at 101 if the consolidated gross debt/EBITDA is below 3.4x prior to July 2016 (below 3.25x after July 2016), which we believe will be met. In addition, there is limited capacity to incur additional debt under the current bond documentation. Therefore if the current capital structure remains in place, we estimate FFO adjusted leverage will decrease below 6x from FY16 (ending June 2016) which, if maintained, could result in a higher IDR. At present, any positive rating action would be limited to one notch.

Improved Business Model

Fitch views BUT's business model as sustainable and sees moderate execution risks in its growth strategy, both consistent with a higher rating. We take a positive view of the group's successful business model evolution, with ongoing strong gains in EBITDA and EBITDA margin. These gains are largely driven by management's measures to optimise the group's product offering (refined range and price mix), owned-store/franchise mix and logistics operations. Fitch expects BUT's EBITDA between FY14 and FY16 to rise to EUR88m (6% margin) from EUR47m (3.7% margin) from a combination of top-line growth and strong gross margin improvement while the fixed cost base remains under control.

Fitch believes that following the acquisition of the 18 Yvrai franchise stores in September 2016, BUT's ability to obtain further gains in profitability will be limited as the bulk of the group's cost structure optimisation comes to an end. Nevertheless, it should be supported by like-for-like sales growth, further improvement in purchasing power from higher volumes and the ongoing development of the higher-margin decoration range.

Supportive Market Environment

BUT's trading environment is improving, driven by firmer French GDP growth prospects (based on Fitch's forecasts: 1.3% in 2016 and 1.4% in 2017, up from 0.2% and 1.1% in 2014 and 2015, respectively) and recovering consumer confidence. BUT's core furniture market in France increased 2.4% in 2015 and stayed strong in the first four months of 2016 (source: IPEA) after three consecutive years of decline. Fitch forecasts continued growth over the next three years and expects this to benefit BUT due to its solid third largest position in the market.

Strong Market Position

According to the IPEA, BUT's market share increased to 13.1% in 2015 from 11.3% in 2013. BUT benefited from an improved product offering and store openings. The top three players' (IKEA, Conforama and BUT) market share grew to 47.1% in 2015 from 41.6% in 2010, to the detriment of smaller independent retailers. Fitch expects BUT's market share to be at least sustainable. We believe that the group has growth opportunities in the French market as Conforama concentrates on its international development. In addition, BUT retains more opportunity to develop in smaller catchment areas than IKEA, whose bigger stores are more adapted to large urban areas.

We forecast BUT's revenues to grow in excess of 6% CAGR over FY16-FY19, due to moderate network expansion, multi-channel development and further improvement in product offering, principally through the extension of the decoration range and development of online sales.

Low Diversification

Low geographic and sales channel diversification remains a key constraint on the ratings. BUT's concentration in the French market increases the group's vulnerability to local market swings and limits growth opportunities over the medium term. Fitch views positively management's implemented cross-channel strategy through the development of 'click and collect' sales, which is supported by a dense store and pick-up point network. Although it is growing fast, BUT's online penetration remains low, at 2.6% of total revenues in FY15. This increases its vulnerability to more developed (either pure online or multi-channel) competitors in a fast-growing segment.

Profitability Supported by Consumer Financing

Credit income generated from consumer financing supports EBITDA, adding approximately 100bps to the EBITDA margin. Consumer finance is a key part of BUT's promotional activity, a strong sales driver, and a source of differentiation against competitors with a 25% credit penetration rate of its customer base. Given the integral role of consumer finance in BUT's business model and the ring-fenced nature of the associated credit risk, Fitch includes consumer finance contribution in its operating EBITDA calculation.

Financial Flexibility

Considering Fitch's view of a structural improvement in the group's business profile, in line with 'B' rated peers, a potential upgrade depends on its financial profile. The maintenance of the current financing structure would allow the company to execute its growth strategy under the new owners, in which case Fitch expects annual average FCF at 2.5% of sales over FY16-FY19 compared with 1.2% over the past four years. This compares well with 'B' non-food retail peers and is driven by the improvement of the group's business model, principally in terms of profitability and management of working capital needs resulting from management's successful optimisation measures. Furthermore, Fitch expects reduced FCF volatility due to increased resilience of the group's business model.

In addition, Fitch forecasts BUT's FFO fixed charge cover to remain stable at 1.6x over FY17-FY19. This is relatively weak compared with peers rated 'B' and reflects the asset-light business model and increased share of directly-operated stores. In our view, this is counterbalanced by the group's adequate liquidity buffer, supported by its cash generative profile along with a moderate appetite for acquisitions.

Senior Secured Notes' Rating

Fitch believes that expected recoveries would be maximised in a going-concern scenario rather than in liquidation given the asset-light nature of BUT's business, where Fitch views the brand value and established retail network as key assets. The expected senior secured debt recovery is underpinned by guarantors representing at least 85% of the group's EBITDA and by noteholders' second-ranking claim on any enforcement proceeds in a distressed sale of assets or the business.

Fitch estimates that senior secured noteholders can expect a recovery rate of 79% (equivalent to RR2), leading to a two-notch uplift for the senior secured instrument rating from the IDR to 'B+'. Fitch has updated its underlying recovery assumptions by increasing its estimate of the group's distressed EBITDA, taking into account the strengthening of the group's business model as well as its growing scale, including upcoming acquisition of the Yvrai stores. Fitch's assumption regarding BUT's EV/EBITDA multiple remains unchanged at 4.5x and reflects the group's lack of diversification, which remains a key constraint to its business profile.

KEY ASSUMPTIONS

Fitch's assumptions below assume no change in capital structure.

-Mid-single digit like-for-like sales growth in FY16, moderating over FY17-FY20 to the lower single digits

-Revenues growing at 7.7% CAGR over FY15-FY19 (FY16: 12% yoy) supported by like-for-like sales growth, owned-store and franchise openings, and stores transfers

-EBITDA margin up at 6.0% in FY16, from 5.2% in FY15, growing to 6.2% by FY19

-Yearly working capital inflows, albeit moderating after June 2016, driven by sales growth and further improvement in management of working capital needs

-Average annual capex at 2.2% of sales over FY16-FY19

-No dividends

-Average FCF at 2.5% of sales over FY16-FY19

-Acquisition spending of EUR52m in FY17 (of which EUR48.2m is for the Yvrai stores) and EUR3m in FY18 for buyback of franchise stores

RATING SENSITIVITIES

Positive: Future developments that, individually or collectively, could lead to positive rating action include:

- Maintenance of the current capital structure resulting in FFO adjusted gross leverage at 6x or below, FFO fixed charge cover at above 1.5x, combined with market share gains and improvements in FCF generation and operating profitability, all on a sustained basis

Future developments that, individually or collectively, would lead to an affirmation of the IDR at 'B-' include:

- A more aggressive financial policy leading to FFO adjusted gross leverage above 6.0x and FFO fixed charge cover of around 1.5x on a sustained basis

- Weaker than expected sales growth and profit margin expansion along with volatile FCF profile

LIQUIDITY

Fitch expects liquidity to remain adequate over the next four years. It should be supported by readily available cash on balance sheet, which Fitch estimates at EUR163m at end-FY16 (FY15: EUR16.5m), and at its lowest at end-FY17 (EUR144m) following to the acquisition of the Yvrai franchises stores. Liquidity should also be supported by the group's FCF generation capacity together with the EUR30m revolving credit facility.