Fitch Affirms Lion/Seneca France 2 at 'B'; Outlook Stable
Fitch has also affirmed 3AB Optique D? veloppement S. A.S.'s EUR365m senior secured notes due 2019 and super senior revolving credit facility (RCF) ratings at 'BB-'/'RR2' and Lion/Seneca France 2 S. A.S.'s EUR75m senior notes due 2019 rating at 'CCC+'/'RR6'.
The rating affirmation reflects Afflelou's robust business and steadily improving cash-flow generation. New business volumes brought by cooperation with closed networks should benefit Afflelou's store network leading to stronger earnings and cash flows. The credit metrics are weak for a 'B' rating, though still adequate given the temporary nature of the most recent earnings volatility due to the business model being in transition. Furthermore, as a health-care credit Afflelou faces little price risk as long as the French reimbursement policy remains favourable, while volume risks are evidently being successfully addressed through the cooperation with selected national care networks.
KEY RATING DRIVERS
Successful Migration to Closed Networks
A strategy revision launched in 2014 towards cooperation with closed networks is beginning to bear fruit, which is evidenced in the reversal of the decline in like-for-like sales and the accelerated store network activity. As the company assists its stores in entering additional care networks, we expect its impact to last well into the financial year ending July 2017 (FY17), leading to an increase in store network sales as well as Afflelou's franchisor fees, with the latter linked to the underlying store activity.
We have therefore raised our overall top-line growth forecast to 13% for FY16 and 5% for FY17, followed by flattening growth thereafter of 2%-3% as the company should have booked the contribution from the currently known targeted closed networks by then.
Operating Margins to Remain Flat
The price-conscious nature of care networks, whereby participating opticians are required to work with selected suppliers and adhere to product offerings and promotional activities, is likely to constrain profitability expansion for Afflelou. In particular, we project group gross margin below the prior years' level, at 47% as the company is aligning its supplier relationships and operational policies with the care networks requirements, leading to a sustained EBITDA margin of 20%-21%% over the rating horizon.
We also point to some margin upside potential from the reduction in the number of directly owned stores (DOSs), improving Afflelou's operating leverage and minimising losses. However, we believe that the reduction in DOSs will be slow, and therefore do not anticipate any meaningful profitability improvement as a result.
Healthy Cash-Flow Profile
New business volumes brought by the care networks should help restore funds from operations (FFO) to a sustainable EUR40m-45m after a slump in FFO to EUR33m in FY15. Notwithstanding the projected trade working-capital outflow due to changes in the supply chain in FY16 of EUR9m, we assume the company will generate consistently positive free cash flows (FCF) with FCF margin increasing towards 9% by FY18. We estimate FCF will be sufficient to easily accommodate bolt-on acquisitions and allow for an uninterrupted accumulation of cash reserves.
Weak Credit Metrics to Improve
Based on our assessment of Afflelou's sustainable cash-flow profile, its credit metrics, most notably, FFO adjusted leverage and FFO fixed charge cover, are weak for its 'B' IDR. Leverage ratios of 7.8x and 7.3x in FY15-16 are high, but we view the levels as temporary while the company is redirecting its business model towards national care networks. Stronger earnings and cash flows should contribute to bringing the leverage below 7.0x by FY17, a level we consider appropriate for the rating given the dominant health-care component in Afflelou's business model, and to a smaller extent, its exposure to conventional retail risks.
Superior Recoveries for Senior Secured Creditors
We use the going-concern approach in our recovery analysis given Afflelou's asset-light business model. After application of an unchanged discount of 15% to FY16E EBITDA of EUR71m, and a distressed EV/EBITDA multiple of 5.5x, we estimate a superior recovery for super senior RCF lenders and senior secured noteholders in 'RR2' resulting in 'BB'/RR2/90% (capped at 90% due to French jurisdiction) for super senior RCF and 'BB-'/RR2/72% for senior secured bond.
Investors in the senior notes, being structurally and contractually subordinated to the senior secured debt class, would have no recoveries in a hypothetical distress scenario resulting in an instrument rating of 'CCC+'/RR6/0%.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Afflelou include
- sales growth of 13% in FY16 and 5% in FY17 based on interim trading and near-term entry into additional closed networks, followed by 2%-3% of top line growth thereafter;
- EBITDA margin at 20%-21%;
- trade working-capital outflow of EUR 8.5m in FY16 linked to supply chain optimisation, followed by annual cash outflow of below EUR1m as working-capital levels normalise from FY17;
- capex at 3% of sales;
- bolt-on acquisitions of EUR7.5m offset by asset and store disposal of EUR10m in FY16; further bolt-on acquisitions of EUR5m per year in FY17-18.
RATING SENSITIVITIES
Negative: Future developments that may, individually or collectively, lead to the IDR being downgraded, include:
- Deterioration of EBITDA and FCF margins, for example as a result of continued weak network activity, negative like-for-like sales growth resulting from increased competitive pressures, the impact of regulatory changes, adverse supplier mix changes or further material increase of the DOS segment.
- FFO adjusted leverage above 7x or no evidence of deleveraging, for example because of operating underperformance or ongoing debt-funded acquisition activity.
- FFO fixed charge cover of 1.8x or below.
Positive: Future developments that may, individually or collectively, lead to the IDR being upgraded, include:
- Steady network activity, for example as a result of successful cooperation with national care networks, leading to improving sales and EBITDA margins, and no negative impact from regulatory changes;
- At least mid-single digit FCF margins sustainably;
- FFO adjusted leverage improving towards 5.5x;
- FFO fixed charge cover improving towards 2.5x.
LIQUIDITY
Comfortable Liquidity Position
We project Afflelou will generate FCF of EUR18m in FY16 and around EUR30m per year thereafter, leading to accumulation of liquidity reserves in excess of EUR100m by FYE18. This robust internal liquidity should comfortably accommodate bolt-on acquisitions of up to EUR10m per year, without compromising Afflelou's liquidity position and credit quality. It also has a committed RCF of EUR30m available until November 2018, which was fully undrawn at the end of April 2016.
Sufficient Maturity Headroom
In the absence of any committed debt amortisations, the company has sufficient refinancing headroom until the maturity of its notes in April 2019. As publicly stated by the company, Afflelou may partly or fully redeem its public debt ahead of the scheduled maturity. Since the timing and magnitude of these debt repurchases are unknown, the current rating assumes the notes will be refinanced or repaid only prior to their final maturity date.
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