Fitch Upgrades RoadChef Notes to 'BB-'/'B'; Outlook Stable
The upgrade reflects Roadchef's ongoing and consistent improvement in operating performance since the 2008 recession. RoadChef's turnaround is mostly complete and its refocused offering is competitive, we perceive the forecast financial metrics of average debt service coverage ratio (DSCR) of 1.50x for the class A2 notes and 1.25x for the class B notes and 2017 EBITDA leverage at 2.9x and 4.5x respectively as strong relative to UK WBS criteria. However, we assess Roadchef's small size of 2017F EBITDA of GBP28.9m as a weakness relative to peers. These include Mitchells & Butlers, whose most junior class is rated at 'BBB-' at 1.4x projected coverage, and Unique, a weaker tenanted operator, whose class A is rated at 'BB' with 1.5x projected coverage.
KEY RATING DRIVERS (KRD)
KRD: Industry Profile - Midrange
Sub-KRD - Operating Environment: Weaker
We perceive motorway service stations (MSAs) as exposed to discretionary spending, changes in the economic environment, and competition. MSAs are likely to be negatively affected by energy and food price rises and from lower consumer confidence. Historically a slowdown in the broader economy has led to slight reductions in motorway traffic volumes (peak to trough 2007-10 decline of 2.4%), which negatively impacts MSAs. We believe that there is competition as distances between different service areas are not large enough to prevent user discretion between sites.
Sub-KRD - Barriers to Entry: Stronger
The minimum distance restriction is three miles between MSA, but we still perceive barriers to entry as high, given the very high start-up costs of around GBP45m for a two-sided site and the requirement to prove the need of a new site to gain planning permission. The operator of a potential new site must also evaluate expected returns potential and may be put off by the existing competition.
Sub-KRD - Sustainability: Midrange
We consider the likelihood of industry fundamental changes as low over the life of the bonds. We view the forecast CAGR in the UK population of 0.6% from 2016 to 2036 as moderately credit positive as it should increase demand. At the same time, there is uncertainty around how traffic volumes may react to increases in fuel prices and technology risk, such as electrification and driverless technology.
KRD: Company Profile - Midrange
Sub-KRD - Financial Performance: Weaker
Historically, RoadChef's performance has been volatile and sensitive to the broader economic environment. However, in the last few years with reduced exposure to volatile fuel sales and development of a varied catering offer, revenue and EBITDA stability has improved. We believe it is too early to determine Roadchef's sensitivity to downturns under the modified business model as it has not yet been through a full cycle. The relatively high operating leverage suggests that performance could still be volatile during a downturn and the business still has a weak cash position.
Sub-KRD - Company Operations: Midrange
RoadChef Finance Ltd is a securitisation of cash flows from UK MSAs operated by RoadChef, the third-largest UK MSA operator with a market share of around 20% and over 40 million visitors per year, after Moto with 42% market share and Welcome Break with 25% market share. The securitised group comprises 15 MSA sites (of the group's 20 or 75%) with 20 forecourts (out of 24 or 83%), and 11 Premier Inn lodges (out of 14 or 79%).
We view as credit positive that the CEO position has been stable for eight years. However, the CFO has changed frequently including following the recent change in ownership from Delek to Antin Infrastructure Partners. However, we view key man risk as low. Fitch considers the product range as diversified relative to other WBS sectors, including food, drinks, gaming, hotels, groceries, some fuel and miscellaneous retail. We also view Roadchef's brand portfolio as good, including McDonalds, Costa, BP, Shell, Days Inn, Spar, WH Smith and Chozen. In terms of operator size, with EBITDA of around GBP28m, RoadChef is a mid - to large-sized operator within the monopolistic MSA industry and benefits from some economies of scale in terms of buying power. Operating leverage is high as a result of the regulatory requirement for motorway service areas to provide core services 24 hours a day, 365 days a year, increasing expected performance volatility.
Sub-KRD - Transparency: Midrange
The business is largely self-operated, and the insight into underlying profitability is reasonable, but does not provide insight into profitability of individual catering revenue streams, although some information is available on an ad-hoc basis. Operations are also relatively simple.
Sub-KRD - Dependence on Operator: Midrange
Other operators are likely to be available, and operator replacement should be possible within a reasonable period of time. However, it may not be so straightforward to find a replacement operator with the same skillset and level of experience as the current management. We evaluate operational and financial commingling with the non-securitised group as significant (e. g. common supply contracts, pension schemes).
Sub-KRD - Asset Quality: Midrange
We consider the assets are reasonably well maintained. Capex averaged 4.8% (GBP7.7m) sales in the previous five years, although there is no minimum maintenance capex covenant. In our view, the sites are well located, distributed throughout England and Scotland and a high proportion are freehold. We believe the secondary market as relatively illiquid due to the high price of sites and there is no alternative use value. In our opinion, current five year investment plan from 2015of around GBP50m is substantial, funded via equity from the new owners in addition to excess cash when possible. This capex should strengthen the business further with site improvements, catering rollout, energy saving initiatives and introduction of a grocery offer.
KRD: Debt Structure
Class A: Midrange
Class B: Weaker
Sub-KRD - Debt Profile:
Class A: Stronger
Class B: Weaker
The class A2 notes are fully amortising on a fixed schedule and the amortisation profile is aligned with the industry and company risk profiles. There are no interest-only periods and minimal concurrent amortisation with subordinated debt. In addition, the subordinated debt is deferrable, meaning non-payment of interest and/or principal would not constitute an issuer event of default. The notes are also fixed rate. The class B notes are fully amortising, but not until 2024 (interest only until then), and the amortisation is back-ended with the class B notes amortising in three years. However, by this time transaction leverage is expected to be very low at around 1.5x. Similar to the class A notes, the class B notes are fixed rate and there is no senior ranking swap liability.
Sub-KRD - Security Package:
Class A: Midrange
Class B: Weaker
The class A notes are senior ranking controlling creditors. The security package comprises fixed and floating charges over the assets of the borrower which is standard for UK WBS transactions. Notably, in our opinion, the non-orphan status of the SPV owned by the borrower's parent, RoadChef motorway holdings ltd slightly undermines the control usually afforded to senior bondholders, as the owner could potentially impact the timing of any enforcement action. This prevents the security package from being graded 'stronger' and 'midrange' in relation to the class A and class B notes. The class B notes benefit from the same security as class A, but are the junior ranking creditor.
Sub-KRD - Structural Features:
Class A: Midrange
Class B: Midrange
The covenant package as a whole is not comprehensive (e. g. EBITDA only restricted payment conditions (RPC) and financial covenant). There is no restriction in relation to cure rights, with the transaction having frequently avoided borrower event of default thanks to cash injections from the previous owners. The RPC level is sub-optimal at 1.50x EBITDA, but there has not yet been any cash leakage. At 1.25x EBITDA, the financial covenant is not optimal, leaving little cushion for underperformance. We view the liquidity facility as midrange at GBP25m or equivalent to around 16 months peak debt service. The counterparty, which is Barclays Bank as the account bank and liquidity provider, is stronger.
Peer Group:
As Roadchef is the only MSA transaction in Fitch's whole business portfolio, the peer analysis centred on comparisons to other whole business portfolio transactions such as pubs, care homes, funeral homes (Dignity) and holiday parks (CPUK). Roadchef is generally well aligned with these peers after adjusting for differences in industry and firm characteristics. RoadChef compares favourably with the average pubco free cash flow DSCR. The difference in ratings is attributable to differences in size. RoadChef generates on average at least 4x less EBITDA than other pubcos and the underlying industries, primarily higher revenue risk.
RATING SENSITIVITIES
Negative: Deterioration in performance could result in negative rating action if there is a significant extension in the current projected FCF DSCR metrics that would move them below 1.3x for the class A notes and 1.1x for the class B notes. Weaker performance could be driven by deterioration in macroeconomic and industry environment, as well as reduced discretionary spending and greater cost pressure as a result of weak UK economic growth and cost driven inflation following the vote to leave the EU.
Positive: Any significant improvement in performance above Fitch's base case, leading to an FCF DSCR above 1.7x for the class A notes and 1.35x for the class B notes, could result in positive rating action. This could occur due to an improvement on the macroeconomic and industry environment. In addition, further performance improvements driven by the on-going catering developments and site refurbishments could positively affect the ratings or Outlooks.
TRANSACTION UPDATE
Operational Performance Update
Adjusted EBITDA to 52 weeks grew by 6.7% on a yoy TTM basis to GBP28.4m, with the strong performance driven by continuing growth in catering revenues as the rollout of McDonalds restaurants and general refurbishment of the sites all continued according to plan during the year. The good performance during the year also marked a continuation of the upward trend with EBITDA having grown by a seven-year CAGR of 8% since the low of around GBP17m in 2009. With debt service constant throughout this period, EBITDA DSCR has improved markedly to 1.52x at the quarter ending April 2016 from a low of 0.78x, when repeated equity injections were required to prevent the transaction from defaulting on the financial covenant in 2009. The latest pension deficit valuations show deficits of GBP3.6m for both the RoadChef Retirements Benefits scheme and the Blue Boar Motorways Ltd Pension scheme, with an annual funding requirement of less than GBP 1m per year. We do not view this as material.
Forecast Assumptions
Fitch projected FCF DSCRs remain in line with the previous review at 1.50x for the class A and 1.25x for the class B notes. Fitch's base case assumptions are slightly more conservative than last year. We assume a recession in 2017-2018 reflecting uncertainty after the UK decision to leave the EU in the Brexit referendum, resulting in weaker internal consumption and a weaker sterling, partly offset by increased likelihood of holiday makers remaining in the UK and foreign tourists. Fitch assumes a higher recovery in 2019-2020. Long-term assumptions are in line with last year's assumptions. Main growth comes from catering sales, which are assumed to grow 2.5% until 2018 and Lodge sales and Other sales, which are assumed to grow by 1% until 2018, increasing thereafter. We forecast the reported FY16 EBITDA of GBP28.4m to grow to GBP30.6m by 2027, representing a CAGR of 0.7%.
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