Fitch Ratings has affirmed its ratings on Rite Aid Corporation (Rite Aid), including its Issuer Default Rating (IDR) at 'B'. In addition, Fitch upgraded Rite Aid's guaranteed senior unsecured notes to 'B+/RR3' from 'B/RR4'. The Rating Outlook has been revised to Positive from Stable. A complete list of rating actions is provided at the end of this release.
KEY RATING DRIVERS
The ratings reflect the improvement in the company's operating performance, credit metrics and liquidity profile over the past 24 months. Rite Aid's EBITDA increased to $1.3 billion in fiscal 2014 (year ended February 2014), after surpassing the $1 billion level for the first time in fiscal 2013. Fitch expects EBITDA to be sustainable at $1.3 billion over the intermediate term, enabling the company to dedicate increased capex towards store remodels and some store relocation activity, as well devote free cash flow (FCF) to debt reduction. Fitch also expects adjusted leverage to trend towards the mid-5x range over the next 24 months versus 5.9x currently and 6.6x in fiscal 2013.
While Fitch expects gross margin to decline in the 20 - 30 basis point range annually due to ongoing pharmacy reimbursement pressure and put some pressure on the current LTM EBITDA margin of 5.1%, Fitch expects same store sales to grow at 2%-3% over the next 24 months resulting in relatively flat EBITDA levels. The same store sales projection is based on front-end same store sales of 1%, prescription volume growth of 1.5%-2% and some pharmacy inflation. Same store sales for the 43-week period ended Dec. 27, 2014 increased 4.3% on front-end same store sales increase of 1% and prescription volume growth of 3.6%. A substantial portion the prescription volume growth has come from Medicaid coverage expansion under the Affordable Care Act (ACA) and there could be some incremental benefit in fiscal 2016.
Rite Aid's operating metrics still significantly lag those of its largest and well-capitalized competitors, with average weekly prescriptions per store of approximately 1,260 and an EBITDA margin of 5.1%, versus Walgreen Co.'s' EBITDA margin at 6.7% and CVS Caremark's retail EBITDA margin at 11.8% (pre-corporate overhead costs). However, the Wellness+ loyalty card program and the pick-up in remodeling activity over the past three years have helped the company stabilize its prescription volume and see modest front-end growth.
Through the end the third quarter, Rite Aid had completed and grand reopened 1,529 wellness stores (33% of store base). Front-end same-store sales in the wellness stores that have been remodeled in the past 24 months were approximately 321 basis points higher than its non-wellness stores, and script growth was 278 basis points higher. Fitch expects Rite Aid to remodel 400-500 stores or 10% of its store base annually over the next two to three years, which is expected to have a modest positive impact on overall sales and profitability. Fitch expects Rite Aid's market share to remain relatively stable over the intermediate term although its position could weaken over time relative to its two larger peers given their ability to leverage their significant scale and partnerships in the complex and evolving healthcare landscape.
Rite Aid has pushed out major debt maturities to 2020 (with the exception of $64 million 8.5% convertible notes due in May 2015) and reduced its cash interest by over a $100 million to $375 million in fiscal 2015, through a series of refinancings and net debt reduction of approximately $550 million between fiscal 2012 and fiscal 2014.
Rite Aid recently paid down $270 million of 10.25% second lien notes due October 2019. In addition, the company has amended and extended its existing $1,795 million senior secured credit facility, to include an increased borrowing capacity of up to $3.0 billion, or up to $3.7 billion when the company repays its 8.00% Senior Secured Notes due 2020 in full (whether at maturity or pursuant to an early redemption) and an extension of the maturity to January 2020. The company expects, at current rates, to save approximately $20.0 million in annual interest expense, based on a $3.0 billion facility, and approximately $50.0 million in annual interest expense, based on a $3.7 billion facility and the redemption of its 8.00% Senior Secured Notes due in 2020. The company used borrowings under its amended and extended senior secured credit facility to repay and retire all of the $1.147 billion outstanding under its Tranche 7 Senior Secured Term Loan due 2020.
Rite Aid has maintained liquidity in the $950 million -- $1.3 billion range for the past three years and Fitch expects FCF - net of capex of approximately $525 million and $70 million related to the acquisition of Health Dialog and RediClinic - to be around $350 million in fiscal 2015. This reflects a $250 million working capital benefit from its supply agreement with McKesson and in part due to lower interest expense as a result of the company's refinancing activities. Fitch expects FCF to be in the $300 million range in fiscal 2016 and $200 million thereafter which should support further debt reduction and reduce leverage to the mid-5x range over the next 24 months from 5.9x currently.
RECOVERY CONSIDERATIONS
The issue ratings shown are derived from the IDR and the relevant Recovery Rating. Fitch's recovery analysis assumes a liquidation value under a distressed scenario of approximately $5.7 billion on inventory, receivables, prescription files and owned real estate.
The $3.0 billion revolving credit facility due January 2020 (or up to $3.7 billion when the company repays its 8.00% Senior Secured Notes due 2020 in full) and the $650 million senior secured notes due August 2020 have a first lien on the company's cash, accounts receivable, investment property, inventory, and script lists, and are guaranteed by Rite Aid's subsidiaries. This gives them outstanding recovery prospects (91%-100%) that support their 'BB/RR1' rating. The senior secured credit facility requires the company to maintain a minimum fixed charge coverage ratio of 1.0x only if availability on the revolving credit facility is less than $175 million at any time.
The $970 million in Tranche 1 and Tranche 2 term loans have a second lien on the same collateral as the revolver and term loans and are guaranteed by Rite Aid's subsidiaries. These are also expected to have outstanding recovery prospects and are rated 'BB/RR1'. With the paydown of $270 million of 10.25% second lien notes due October 2019, the recovery on the guaranteed unsecured notes has improved and they are expected to have good recovery prospects (51%-70%). Therefore, Fitch is upgrading the ratings on the $1.7 billion guaranteed unsecured notes to 'B+/RR3' from 'B/RR4'. The unsecured non-guaranteed notes are assumed to have poor recovery prospects (0%-10%) in a distressed scenario.
RATING SENSITIVITIES
Positive Rating Action: A positive rating action could result if Rite Aid sustains positive comparable store sales and EBITDA in the $1.3 billion range or better, enabling to company to further reduce debt and adjusted debt/EBITDAR towards the mid-5.0x range over the next 24 months.
Negative Rating Action: A negative rating action could result from deteriorating sales and profitability trends that take EBITDA below $1 billion (as seen in fiscal 2010 through fiscal 2012) and leverage returns to over 7.0x.
Fitch has affirmed the following ratings for Rite Aid:
--Long term IDR at 'B';
--Secured revolving credit facility at 'BB/RR1';
--First and second lien senior secured notes at 'BB/RR1';
--Non-guaranteed senior unsecured notes at 'CCC+/RR6'
Fitch has upgraded the following rating for Rite Aid:
--Guaranteed senior unsecured notes to 'B+/RR3' from 'B/RR4'.
The Rating Outlook has been revised to Positive from Stable.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 28, 2014);
--'Recovery Ratings and Notching Criteria for Nonfinancial Corporate Issuers' (Nov. 19, 2014).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=813588
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=969115
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