Petco Holdings Inc. Downgraded To #B-# On Weak Performance

Stocks and Financial Services Press Releases Friday January 12, 2018 08:51
NEW YORK--12 Jan--S&P Global Ratings

NEW YORK (S&P Global Ratings) Jan. 11, 2018--S&P Global Ratings today lowered its corporate credit rating on San Diego-based specialty pet retailer Petco Holdings Inc. to 'B-' from 'B'. The outlook is negative. In conjunction with the lower corporate credit rating, we lowered our issue-level ratings on the company's $2.5 billion first-lien term loan due 2023 to 'B-' from 'B'. The '3' recovery rating is unchanged and indicates our expectation for meaningful (50%-70%; rounded estimate: 60%) recovery in our default scenario.

The downgrade reflects our expectation that competitive pressures in the pet retailing space will continue as the company aggressively competes for market share. As a result, we expect prolonged weakness in the company's comparable same-store sales trends, which will hurt profits and cash flows, over the next several quarters.

We believe e-commerce players including Chewy and Amazon will meaningfully increasing their market share at the expense of sales from physical retail stores, which puts Petco's performance at risk given its small e-commerce presence. Third-quarter same-store sales were negative, declining in the mid-3% area—the largest quarterly decline year to date—and we expect sales comparisons to remain soft in the next year. We think the company will execute initiatives to grow its e-commerce presence and add pet services at physical stores as strategies to turn around performance trends. However, we do not expect any notable benefits to occur anytime soon. Because of these factors, we expect debt to EBITDA to rise above 6.5x over the next year and fixed charge coverage of 1.4x. The negative outlook reflects our expectations that Petco's credit metrics will remain weak for the ratings given the intensely competitive retail environment, soft traffic trends, and declining profits. We also think rating downside risk has increased because of the possibility that customer traffic will continue shifting to online and mass channels. We forecast leverage above 6.5x and fixed-charge coverage ratio around 1.4x in the next several quarters.

We could lower the rating into the 'CCC' category if we conclude profits or cash flows are declining more than we anticipate because of heightened competitor incursions leading us to believe the company's capital structure becomes unsustainable, or there is potential for a debt buyback. This could result from prolonged negative same-store sales cadence driving strained cash flows that leads to borrowings on the revolver. We could also see the fixed-charge coverage ratio dropping to the low-1x area in this situation. An outlook revision back to stable would be predicated on Petco's ability to rebound from negative same-store sales and improve its credit profile such that debt to EBITDA is sustained at the 6x-area. We would also need to believe a debt exchange is unlikely, the company can grow its online sales without hurting profitability, and cost savings initiatives boost profits.

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