OREANDA-NEWS. Fitch Ratings has affirmed Punch Taverns Finance Plc's (Punch A) Super Senior Hedge Notes (SSHN), class A1(F), A2(F), A1(V), A2(V) and class M3 notes, as follows:

GBP109.4m floating-rate SSHN due 2021: affirmed at 'BB+'; Outlook Stable
GBP202.5m Class A1(F) fixed-rate notes due 2026: affirmed at 'BB'; Outlook Stable
GBP137.4m Class A2(F) fixed-rate notes due 2025: affirmed at 'BB'; Outlook Stable
GBP67.5m Class A1(V) fixed-rate notes due 2026: affirmed at 'BB'; Outlook Stable
GBP45.8m Class A2(V) fixed-rate notes due 2025: affirmed at 'BB'; Outlook Stable
GBP300m Class M3 floating-rate notes due 2027: affirmed at 'B-'; Outlook Stable

The affirmation reflects that in the year to March 2015, total EBITDA (excluding the impact of Punch Taverns plc support from the previous year) declined by 6% to GBP123.2m (slightly ahead of the Fitch base case). This was driven by a 7% reduction in the number of pubs over the same period as primarily weaker pubs continued to be sold. EBITDA per pub grew by around 2% in the year to March 2015 and by a CAGR of around 2% over the past three years. The key drivers of the per pub EBITDA growth were increased capex (improving the average quality of the pubs), an improving economic environment and sale of predominantly non-core, lower EBITDA pubs, which mechanically improves the average EBITDA. Data availability at Punch A level is limited, but the reported like for like net income growth for the core estate over the past two years at Punch Group plc level (2014, 2015: 1.3% and 0.3%, respectively) indicates that disposals are not the only contributor to per pub EBITDA growth.

Gross EBITDA leverage for the SSHN, Class A and Class M notes has reduced to 0.9x, 4.6x and 7.0x from 1.0x, 4.7x and 7.2x, respectively, at the restructuring in October 2014. This was primarily due to GBP39.8m of disposal proceeds generated during the first two quarters of 2015, GBP13.9m of which was used to prepay the SSHN (which is ahead of Fitch's expectation of GBP3.4m at the time of restructuring). The Stable Outlooks reflect the expected continued stabilisation in transaction operating performance over the next two years.

The transaction is a securitisation of tenanted pubs in the UK. As of March 2015 the transaction consisted of 2,108 pubs (1,714 pubs in the core estate and 394 in the non-core estate).

KEY RATING DRIVERS
Industry Profile - Midrange
While the pub sector in the UK has a long history, trading performance for some assets has shown significant weakness in the past with the sector being considered in a structural decline for the past three decades due to demographic shifts, greater health awareness and the growing presence of competing offerings. Exposure to discretionary spending is high and revenues are therefore inherently linked to the broader economic cycle. Competition is viewed as high including off-trade alternatives, and barriers to entry are low, despite increasingly demanding regulations. Despite the on-going contraction, Fitch views the eating- and drinking-out market as sustainable in the long term, supported by the strong pub culture in the UK.
Sub-key rating drivers (KRD) Operating environment: Weaker; Barriers to entry: Midrange; Sustainability: Midrange

Company Profile - Midrange
EBITDA per pub has stabilised over the past two years, mainly as a result of extensive disposals of weakly performing non-core pubs and increased investments in the core estate following years of capex underspend. The leased/tenanted business model makes it more challenging for the Punch group to adapt to the growing eating-out market in the UK as it has reduced control over publicans' strategy and less cash to spend on capex due to performance declines. Furthermore, limited visibility with respect to the tenants' profitability means that the sustainability of the cash flows generated by tenanted pubs is more difficult to estimate. However, the continued disposals of non-core pubs, combined with increased capex invested in the core estate, are expected to result in an overall improved quality of the estate in the foreseeable future.

Sub-KRDs: Financial performance: Weaker; Company operations: Midrange; Transparency: Weaker; Dependence on operator: Midrange; Asset quality: Weaker

Debt Structure - Midrange (SSHN, A1(F), A2(F), A1(V), A2(V)) and Weaker (M3)
The Midrange assessment of the debt structure with respect to the senior debt is a reflection of the partial repayment from cash sweep (SSHN, A1(V), A2(V)) and scheduled amortisation (A1(F) and A2(F)), which contributes to some de-leveraging. This therefore somewhat mitigates risks around the ability to refinance debt (or the reliance on core pub disposal proceeds, which is another way to fund debt repayment) at or prior to legal maturity. However, the junior ranking class M3 notes are not expected to benefit from any amortisation prior to maturity.

There is some floating rate exposure due to the unhedged floating-rate SSHN, which Fitch has taken into account in its base case via interest rate stresses. The security package is standard for UK WBS transactions. Operational and financial covenants are satisfactory, although we note the exclusion of the bullet repayments for the purpose of calculating the free cash flow debt service coverage ratio (FCF DSCR) as well as the possibility of preventing a covenant breach through the availability of disposal proceeds, which are part of the FCF definition. However, we view the inclusion of a leverage covenant as mitigating this relative weakness. In terms of cash lockup provisions, only a group service payment of up to 2% of EBITDA can be up-streamed (i.e. paid to outside the securitised group) if a) no borrower event of default has occurred and b) the net senior leverage is below the closing level, which is a credit positive. The liquidity facility is structured to cover 18 months of peak debt service. However, this represents effectively only interest payments on the rated notes and scheduled amortisation with regard to the class A1(F) and A2(F) notes (excluding final bullets).

Typically UK WBS allow debt tranches ranking below the most senior notes to defer interest and scheduled principal payments if available cash is insufficient to cover debt service. However, the ratings of the A(F) notes and the A(V) are aligned, given that a failure to pay interest (or final principal) on the more junior ranking A(V) notes would result in an issuer event of default due to the A(V) notes' non-deferability. The most senior ranking SSHN are rated one notch above the non-deferrable subordinate ranking class A(F) and A(V) notes due to their earlier maturity in 2021 and lower refinance risk compared with the class A notes (as the SSHN mature in 2021 they are not exposed to a potential inability of the class A notes to refinance in 2025 and 2026). However, a payment default under the class A notes prior to the SSHN's full repayment would still trigger an issuer event of default, affecting the then outstanding SSHN (limiting the uplift to one notch).

Sub-KRDs: Debt profile: Midrange (SSHN, classes A1(F), A2(F), A1(V), A2(V)) and Weaker (class M3); Security package: Stronger (SSHN) and Midrange (classes A1(F), A2(F), A1(V), A2(V), M3); Structural features: Midrange

Peer Analysis
Given the unusual debt profile with cash sweeps/traps as well as the refinance risk that no other WBS deal faces (except Arqiva's junior tranche), the leverage metrics and deleveraging profile become more relevant for the ratings. Punch's current leverage looks quite low in comparison with peer transactions. However, there is a significant amount of uncertainty in relation to deleveraging (given that, unlike for peers transactions, it relies on disposal proceeds) in addition to significant refinancing risk, which constrains the ratings.

RATING SENSITIVITIES
The ratings could change if the operating performance falls materially above or below Fitch's base case. Negative rating action would be likely if disposal proceeds were insufficient to reduce leverage via prepayments leading to a deterioration of long-term leverage expectations. Furthermore, the anticipation of a failure to refinance maturing debt tranches would lead to negative rating action.

TRANSACTION PERFORMANCE
The new post restructuring coverage covenants are EBITDA DSCR rolling four quarters and FCF DSCR rolling four quarters. They were reported at 1.7x and 2.0x, respectively, as at March 2015 (FCF DSCR is higher than EBITDA due the covenanted inclusion of disposal proceeds in the FCF DSCR calculation). The projected (synthetic - due to lack of scheduled amortisation) DSCR metrics for the SSHN have improved significantly to 7.37x from 5.53x at the restructuring in October 2014. In addition, the projected DSCR metrics have also improved for the class A and class M notes to 2.16x and 0.90x from 1.62x and 0.81x. This is primarily due to greater repayment of the SSHN than was projected under Fitch's base case at the restructuring (around GBP20m) in addition to a positive revision in Fitch's base case assumption of FCF CAGR (now around -1.5%). This is justified by the slight outperformance of the previous Fitch base case and the assumed gradual improvement in estate quality due to disposals (as evidenced by improving EBITDA per pub) in addition to peer alignment.

While the FCF DSCR of the SSHN and the class A notes appear quite high, the ratings are weighed down by Fitch's assessment of the industry and company profile containing weaker assessments for a number of sub-KRDs.

The ratings are also constrained by the limited projected deleveraging and significant refinance risk. Fitch does not factor disposal proceeds in its base case projections, resulting in base case gross debt to EBITDA multiples (not including swap MtM) of 0.8x (SSHN), 2.5x (A1(F) and A2(F)), 3.5x (A1(V) and A2(V)) and 6.2x (M3) in 2021 (the maturity of SSHN). Hence, even the senior ranking SSHN cannot be fully repaid out of excess cash flow under the base case, and partly rely on being refinanced (or on core pub disposal proceeds). Further refinancing needs arise when the class A notes reach maturity in 2025 and 2026.