Overview -- U.S.-based United Distribution Group Inc. (UDG) entered into $425 million senior secured credit facilities to acquire GHX Holdings LLC and refinance existing debt. -- We have assigned our 'B-' corporate credit rating to UDG. We have assigned our 'B-' issue-level rating and '3' recovery rating to the company's $290 million first-lien credit facilities, and a 'CCC' issue-level rating and '6' recovery rating to the company's $135 million second-lien term loan. -- The outlook is stable, reflecting our belief that UDG's credit measures will remain in line with the 'B-' corporate credit rating given our expectation that GHX's energy end markets will offset weakness in the coal mining end markets of subsidiary United Central Industrial Supply LLC. Rating Action On Dec. 20, 2012, Standard & Poor's Ratings Services assigned its 'B-' corporate credit rating to Bristol, Tenn.-based United Distribution Group Inc. The outlook is stable. At the same time, we assigned a 'B-' (the same as the corporate credit rating) issue-level rating to UDG's $290 million first-lien credit facilities, consisting of a $40 million revolving credit facility and a $250 million senior secured first-lien term loan. The recovery rating on the credit facilities is '3', indicating our expectation for meaningful (50% to 70%) recovery in the event of payment default. We also assigned a 'CCC' (two notches lower than the corporate credit rating) issue-level rating to UDG's $135 million second-lien term loan. The recovery rating on the term loan is '6', indicating our expectation for negligible (0% to 10%) recovery in the event of payment default. The company used proceeds from the credit facilities to acquire GHX Holdings LLC and refinance existing debt. Prior to the transaction's closing, UDG was known as ASP United Holding Co. The borrowers on the credit facilities are United Central Industrial Supply LLC (United Central) and GHX Holdings LLC (GHX), which are two subsidiaries of UDG. Rationale The 'B-' corporate credit rating on UDG reflects our view of the company's "vulnerable" business risk profile and its "highly leveraged" financial risk profile. We believe key business risks include the company's relatively modest size; a dependence on the cyclical mining and energy end markets for a large portion of its revenues and earnings; and risks the mining supply company faces integrating GHX. In October 2012 UDG acquired GHX, a fluid transfer and sealed products distributor to companies participating in energy end markets, for $240 million, or 8x trailing-12-month EBITDA. We consider UDG's financial risk profile to be highly leveraged, based on our expectation that the company will maintain leverage between 5x and 6x in 2012 and 2013. Under our base-case scenario, we expect that UDG's revenues in 2012 and 2013 will be flat to slightly up over 2011 levels, pro forma for the transaction, as well as for acquisitions that both United Central and GHX made in 2011. This is driven by our assessment that United Central's currently weak coal mining end markets will be flat to slightly down in 2012 and 2013, whereas sales to GHX's energy end markets will be up modestly over that time period. We estimate that ASP will generate between $65 million and $75 million of pro forma EBITDA in 2012 and 2013. We expect total debt (pro forma for the transaction and including adjustments for operating leases) to approximate $390 million by year-end 2012. Given our forecast for EBITDA to remain within the same range in 2012 and 2013, leverage is likely to be maintained between 5x and 6x in 2012 and 2013, with interest coverage of between 2x and 3x, metrics we would consider to be in line with the 'B-' rating given the company's vulnerable business risk profile. Pro forma for the transaction, approximately 65% of sales will be to mining (predominantly coal) end markets, whereas 20% of sales will be to upstream oil and gas end markets. Standard & Poor's believes that a warmer-than-normal winter and natural gas substitution have accelerated what we view as a sustained decline in the economic viability of thermal coal produced in the Central Appalachia (CAPP) basin, where a majority of United Central's customers are located. As a result, many of United Central's key customers have closed mines, which we believe will negatively affect its sales growth over the next several quarters. GHX's sales growth is affected by demand for oil and gas. Standard & Poor's believes the longer-term outlook for crude oil prices and improving natural gas prices in the U.S. should support strong demand for rigs and related services. As a result, we believe GHX's sales should modestly improve in 2012 and 2013. Prior to the close of the transaction, UDG was known as ASP United Holding Co. UDG is the parent holding company of United Central and GHX. United Central distributes approximately 70,000 products from more than 1,200 manufacturers, including mining bits, roof control products, and other maintenance, repair and operations products to the $2.3 billion North American mine supply market. GHX custom-fabricates more than 50% of its products, including hoses and fittings, gaskets and sealing products, and valves. As a result of its custom fabrications, GHX's margins are slightly better than United Central's. Liquidity In our view, UDG's liquidity position is "adequate". Our view of the company's liquidity profile includes: -- An expectation that liquidity sources will exceed uses by at least 1.2x over the next one to two years. -- An expectation that liquidity sources will continue to exceed uses, even if EBITDA were to decline by up to 15%. -- An expectation that the company would not breach covenant test measures even with a 15% drop in EBITDA. Pro forma for the transaction, we estimate that the company will have between $1 million and $2 million of cash on its balance sheet by year-end 2012. The company's credit facilities have a maximum total leverage covenant of 7.5x, which begins to step down in 2015. Based on our operating expectations, we expect UDG to maintain adequate headroom on its covenant. We expect working capital to be a modest use of cash in 2012 and 2013, and for the company to generate between $25 million and $35 million of free operating cash flow each year. The nearest debt maturity will occur in 2017, when the company's $40 million revolving credit facility matures. Recovery analysis For a complete recovery analysis, please see the recovery report on UDG, to be published on RatingsDirect following the release of this report. Outlook The rating outlook is stable, reflecting our belief that UDG's credit measures will remain in line with the 'B-' corporate credit rating, given our expectation that GHX's energy end markets will partly offset weakness in United Central's coal mining end markets. We expect the company to maintain leverage between 5x and 6x over the next several quarters. Our ratings incorporate the expectation that operating cash flow will remain adequate to finance internal working capital needs and capital expenditures. We could lower the ratings if the company's liquidity position deteriorates such that we deem it to be "less than adequate". This could occur if market deterioration, particularly in UDG's key coal mining end market, leads to lower-than-expected EBITDA or higher-than-expected borrowings on the company's revolving credit facility, which could result in reduced headroom on the company's covenant. We view an upgrade as unlikely over the near term; however, we would consider raising the ratings if leverage fell to below 5x and the company's liquidity position strengthened. Specifically, we would consider an upgrade if revenues increased in the double digits and if gross margins improve by about 200 basis points. Related Criteria And Research -- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Key Credit Factors: Methodology And Assumptions On Risks In The Mining Industry, June 23, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List New Ratings; Outlook Action United Distribution Group Inc. (The) Corporate Credit Rating B-/Stable/-- GHX Holdings LLC United Central Industrial Supply Company LLC Senior Secured US$40 mil 1st lien revolver bank ln due 2017 B- Recovery rating 3 US$250 mil 1st lien term bank ln due 2018 B- Recovery rating 3 Senior Secured US$135 mil 2nd lien term bank ln due 2018 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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