TEXT-S&P affirms Jo-Ann Stores ratings, outlook now stable

Tue Oct 9, 2012 9:46pm BST

Related Topics

Overview
     -- U.S. fabrics and crafts retailer Jo-Ann Stores Inc.'s indirect parent, 
Jo-Ann Stores Holdings Inc. (Holdings) is issuing $325 million of senior 
unsecured PIK notes to finance a dividend to equity holder Leonard Green & 
Partners.
     -- We are assigning a 'B' corporate credit rating to Holdings and a 
'CCC+' issue-level rating to the proposed notes.
     -- We are affirming our ratings on Jo-Ann Stores, including the 'B' 
corporate credit rating, and revising the outlook to stable from positive.
     -- The stable outlook reflects our view that the proposed debt issuance 
will cause financial ratios to improve, but to remain within levels indicative 
of a "highly leveraged" financial risk profile.


Rating Action
On Oct. 9, 2012, Standard & Poor's Ratings Services affirmed its 'B' corporate 
credit rating on Hudson, Ohio-based Jo-Ann Stores Inc. and revised the outlook 
to stable from positive. In addition, we are assigning a 'B' corporate credit 
rating to Jo-Ann Stores Holdings Inc. (Holdings). 

We assigned a 'CCC+' (two notches below the corporate credit rating) 
issue-level rating to the company's proposed $325 million senior unsecured 
paid-in-kind (PIK) notes due 2019. The recovery rating is '6', indicating our 
expectation of negligible (0% to 10%) recovery for noteholders in the event of 
a payment default.

At the same time, we affirmed the 'B+' (one notch above the corporate credit 
rating) issue-level rating on the company's $650 million senior secured term 
loan B facility due 2018. The recovery rating is '2', indicating our 
expectation of substantial (70% to 90%) recovery for lenders in the event of a 
payment default. We also affirmed the 'CCC+' (two notches below the corporate 
credit rating) issue-level rating on the company's $450 million senior 
unsecured notes due 2019. The recovery rating is '6', indicating our 
expectation of negligible (0% to 10%) recovery for noteholders in the event of 
a payment default.

Rationale
The rating action reflects our view that the company's financial ratios will 
weaken following the proposed debt issuance, but will return to near current 
levels over the next 12 months, including adjusted total debt to EBITDA 
approaching 7x after the debt issuance that improves to near 6x. We no longer 
forecast  an improvement in the company's financial ratios to levels 
indicative of an "aggressive" financial risk profile under our criteria, which 
was the primary basis for our previous positive outlook. Profit growth  
remains the primary driver of ratio improvement in our view.

Our ratings on Jo-Ann Stores reflect its "weak" business risk profile and 
"highly leveraged" financial risk profile under our criteria. Our business 
risk assessment reflects our analysis that the company needs to make continued 
capital investment in store enhancements to maintain its competitive position. 
It also reflects Jo-Ann's participation in the competitive and highly 
fragmented craft and hobby retail industry, as well as the seasonal nature of 
its earnings. Our financial risk assessment reflects our expectation for 
financial policies to remain very aggressive under financial sponsor 
ownership, as confirmed by the proposed debt-financed dividend. Given this 
proposed issuance, we now forecast that financial ratios will improve but 
remain within levels indicative of a highly leveraged financial risk profile. 
Below is our revised financial ratio forecast for fiscal year-end January 2013 
and for fiscal year-end January 2014, respectively:

     -- Lease-adjusted total debt to EBITDA increases to nearly 7x from nearly 
6x, and recedes to 6.3x by fiscal year-end January 2013 and to 6.0x by fiscal 
year-end January 2014. Our prior forecast was for leverage to decrease to 5.6x 
and then to 5.2x, respectively.
     -- Funds from operations (FFO) to total debt falls to 12.0% from 14.2%, 
and increases to 12.3% by fiscal year-end January 2013 and then to 12.6% by 
fiscal year-end January 2014. Our prior forecast was for FFO to total debt to 
increase to about 15% and then to nearly 16%, respectively.
     -- EBITDA coverage of interest falls to 2.0x (pro forma to reflect the 
full interest expense impact of the proposed issuance) from 2.3x, and 
increases to 2.4x  by fiscal year-end January 2013 and then falls to 2.3x by 
fiscal year-end January 2014 as the full interest expense impact is reached. 
Our prior forecast was for EBITDA coverage of interest to increase to 2.5x and 
then to 2.7x, respectively.

Financial ratios indicative of a highly leveraged financial risk profile 
include total debt to EBITDA above 5x and FFO to total debt below 12%. 
Financial ratios indicative of an aggressive financial risk profile include 
total debt to EBITDA between 4x and 5x and FFO to total debt between 12% and 
20%.

Standard & Poor's economists believe the risk of another U.S. recession during 
the next 12 months is between 20% and 25%. We expect GDP growth of just 2.2% 
this year and only 1.8% in 2013, consumer spending growth of between 2.0% and 
2.3% per year through 2013, the unemployment rate remaining at or above 8% 
through late 2013, and crude oil (WTI) finishing 2012 at $93.75 per barrel and 
finishing 2013 at $89.68 per barrel. (See "U.S. Economic Forecast: He's Buying 
A Stairway To Heaven," published Sept. 21, 2012.) Considering these economic 
forecast items, our base-case forecast for the company's operating performance 
over the next two years is as follows:

     -- Revenue growth in the mid-to-high-single-digit percent area. Fiscal 
2013 growth is boosted by an extra week; the company's plan to continue adding 
new stores and remodeling existing ones also provides a boost in both years.
     -- Gross margin is slightly higher, as elevated input costs continue to 
partly offset modest gains from private-label and direct-sourcing initiatives.
     -- Operating expenses grow at a slower rate than revenue, with growth 
principally from store development initiatives.
     -- Debt repayment is limited to contractual debt amortization.

We view the company's financial policies to be very aggressive, primarily 
because of the majority equity ownership by the financial sponsor, Leonard 
Green & Partners L.P. This view incorporates our expectation for Jo-Ann to 
prioritize capital investments and dividends over accelerated debt repayment, 
a strategy that is evident in the proposed debt-financed dividend. Leonard 
Green took Jo-Ann Stores private through a leveraged buyout in March 2011.

The business risk assessment incorporates our opinion that the industry will 
remain competitive and highly fragmented. We believe the top three companies 
control about one-third of industry share, with Jo-Ann Stores trailing 
Michaels Stores and Hobby Lobby. We believe these three companies will 
continue to invest in store expansion to gain industry share and to contribute 
to growth.

Jo-Ann is highly dependent on discretionary consumer spending, and we believe 
the company relies on a loyal, yet narrow base of repeat customers for growth. 
For same-store sales growth to consistently exceed GDP growth, the company 
will need to expand its customer base and broaden its customer profile, likely 
through targeted marketing campaigns via multiple channels. We believe such 
initiatives are under way, but it is still too early to gauge the potential 
benefits.

There is significant seasonality in the company's business. The majority of 
sales take place in the third and, to a greater extent, fourth quarter. 
Heightening this risk is the long ordering lead times the company's suppliers 
require. For example, holiday season merchandise is typically ordered in 
February or March. As such, misjudging consumer preference or demand could 
have a material adverse impact on financial results.

We believe the company will be able to continue to benefit from operating 
expense leverage, though not to the extent achieved in recent years. An 
enhanced store base and increased direct sourcing of products has helped 
profitability. We calculate gross margin has improved by about 350 basis 
points since fiscal 2007, and we believe increased direct product sourcing 
contributed meaningfully to this improvement. The company has also efficiently 
managed its operating expenses. Since fiscal year 2007, operating expenses 
have increased at a compound annual growth rate (CAGR) of less than 1.5% while 
revenue has increased at a CAGR of about 3.5%.

Liquidity
We believe Jo-Ann Stores has adequate liquidity, with cash sources expected to 
exceed cash uses over the next 24 months. Cash sources primarily include 
surplus cash, funds from operations, and revolver availability. Cash uses 
primarily include working capital, capital expenditures, and debt 
amortization. Our liquidity assessment includes the following factors, 
expectations, and assumptions:

     -- We forecast cash sources to exceed cash uses by more than 1.2x over 
the next 12 months and to remain positive over the next 24 months.
     -- We forecast net sources would remain positive even if EBITDA were to 
decline 15%.
     -- We believe the company will maintain excess availability under its 
revolving credit facility so that no material financial ratio maintenance 
covenants would apply.
     -- Contractual debt amortization is low at $6.5 million per year.
     -- Debt maturities are favorable, with the revolving credit facility due 
in 2016, term loan due in 2018, the senior notes due in 2019, and the proposed 
senior unsecured PIK notes due 2019.

As of July 28, 2012, we calculate total liquidity of nearly $320 million, with 
revolver availability of nearly $300 million. Revolver availability is an 
average of $285 million over the past four quarters, and total liquidity has 
been above $300 million over the past three quarters. Liquidity will fall in 
the third quarter as the company prepares for its busy holiday season.

We forecast the company can generate positive free cash flow, even after 
accounting for its store expansion and remodel plan. However, after accounting 
for the proposed dividend, discretionary cash flow, on a cumulative basis, is 
forecast to remain negative for at least the next three years. This also 
assumes no additional dividends are paid over the next three years.

Recovery analysis
For the complete recovery analysis, please see the recovery report on Jo-Ann 
Stores, to be published on RatingsDirect following this report.

Outlook
The outlook is stable, reflecting our forecast that the proposed debt issuance 
will lead to some improvement in financial ratios, but they will remain within 
levels indicative of a highly leveraged financial risk profile.

We could lower our ratings if positive operating performance stalls or 
worsens, causing financial ratios to remain near pro forma levels, including 
adjusted leverage in the high-6x area.

We could raise our ratings if operating performance exceeds our current 
expectations or, though we consider this less likely, if a change in financial 
policies allows financial ratios to reach levels indicative of an aggressive 
financial risk profile, including adjusted leverage of 5x. Based on 
second-quarter fiscal 2013 results and pro forma for the proposed debt 
issuance, EBITDA growth of about 37% or debt reduction of nearly $600 million 
is necessary for adjusted leverage to reach 5x.

Related Criteria And Research
     -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
     -- Liquidity Descriptors for Global Corporate Issuers, Sept. 28, 2011
     -- 
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4765458&rev_id=11&sid=805195&sind=A&", April 15, 2008

Ratings List

Ratings Affirmed; Outlook Action
                                        To          From
Jo-Ann Stores Inc.
 Corporate Credit Rating                B/Stable/-- B/Positive/--

Ratings Affirmed

Jo-Ann Stores Inc.
 Senior Secured                         B+                 
  Recovery Rating                       2                  
 Senior Unsecured                       CCC+               
  Recovery Rating                       6                  

New Rating

Jo-Ann Stores Holdings Inc.
 Corporate Credit Rating                B/Stable/--
 Sr unsecured $325 mil 8.75% due 2019   CCC+
   Recovery Rating                      6


Complete ratings information is available to subscribers of RatingsDirect on 
the Global Credit Portal at www.globalcreditportal.com. All ratings affected 
by this rating action can be found on Standard & Poor's public Web site at 
www.standardandpoors.com. Use the Ratings search box located in the left 
column.
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