PetSmart Inc. Downgraded To #B# On Expectations For Continued Soft Performance And Weakening Credit Metrics

Stocks and Financial Services Press Releases Tuesday September 19, 2017 08:51
NEW YORK--19 Sep--S&P Global Ratings
NEW YORK (S&P Global Ratings) Sept. 18, 2017--S&P Global Ratings today loweredits corporate credit rating on Phoenix-based specialty PetSmart Inc. to 'B'from 'B+'. The outlook is negative.

In conjunction with the lower corporate credit rating, we lowered ourissue-level ratings on the company's debt. We lowered the issue-level ratingon the $4.3 billion first-lien term loan due 2022 to 'B' from 'B+'. The '3'recovery rating is unchanged and indicates our expectation for meaningful(50%-70%; rounded estimate: 65%) recovery in our default scenario.

We lowered the issue-level rating on the company's $1.35 billion seniorsecured notes due 2025 to 'B' from 'B+'. The recovery rating on these securednotes remains '3', indicating our expectations for meaningful (50%-70%;rounded estimate: 65%) recovery in our default scenario.

We also lowered our issue-level rating on the $1.9 billion senior unsecurednotes due 2023 and the $650 million senior unsecured notes to 'CCC+' from'B-'. The '6' recovery rating is unchanged, reflecting our expectation fornegligible (0%-10%; rounded estimate: 0%) recovery.

The downgrade on PetSmart reflects our lower expectation for profits and cashflows that will delay the anticipated improvement in credit metrics. Factorscontributing to our downward revisions include greater competition in the petretailing space with mass retailers and other online retailers competing

aggressively for pet food market share. We also think management turnover willcomplicate operational and acquisition execution. The company reported softsame-store sales in second quarter 2017 of about negative 5%, and we expectsales comparisons to remain weak for the next year. We also expect debt toEBTIDA to remain in the high-7x area in the next several quarters and interestcoverage around mid-2x. Weak performance trends and credit metrics are partlymitigated by PetSmart's diversified sales channel and good cash flowgeneration that should still allow for modest debt reduction, though somewhatless than we previously anticipated.

The outlook is negative and reflects the risk that operating performance coulddeteriorate more than our current forecast, causing leverage to stay atelevated levels in the high-7x area and EBITDA coverage in mid-2x area. Wethink underperformance could come from stiff competition from e-commerce, massand other retailers including supermarkets, or prolonged meaningful pricediscounting at Chewy's to attractive new customers, which reduces consolidatedprofits and further weakens credit metrics.

We could lower the rating if competitive pressures and continued softness insame-store sales cause meaningful profit and cash flow declines, furtherreducing prospects for potential deleveraging. In this instance, we wouldexpect to see interest coverage to decline to about 2x and cash flowsdeclining to about $300 million or less. We could also see negativesame-store sales sustained at the 5% area and a 50- to 75-basis-point declinein EBITDA margins.

We could revise the outlook back to stable if the combined companies'performance exceeds our expectations. In this scenario, performance improvesto slightly positive same-store sales, debt to EBITDA sustained under 7x andwe believe the company will not pursue meaningful debt-funded dividend oracquisition over the next 12 months. In this case, PetSmart capitalizes on itsleading market share coupled with Chewy's growing online penetration toachieve good performance improvement with modest strengthening in EBITDAmargins.

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