August 17, 2017 / 2:21 PM / 2 years ago

Fitch Affirms Brinker's IDR at 'BB+' IDR; Outlook Revised to Negative

(The following statement was released by the rating agency) CHICAGO, August 17 (Fitch) Fitch Ratings has affirmed Brinker, International, Inc.'s (Brinker) Issuer Default Rating (IDR) at 'BB+' and revised its Rating Outlook to Negative from Stable. Brinker's ratings reflect its moderately high leverage, meaningful free cash flow, and the position of Chili's Grill & Bar (Chili's) as one of the largest U.S. casual dining chains in the U.S. The company's ratings consider secular challenges in the casual dining segment that Fitch expects to continue in the intermediate term, Brinker's weak comparable restaurant sales (comps) trends, and the chain's market share loss in recent years. The Outlook revision to Negative incorporates the risk that Brinker's efforts to redefine Chili's value proposition, improve restaurant-level execution, and strengthen its takeout capabilities may not result in a sustained improvement in comps and that share losses may continue. Leverage is also at the high end of Fitch's expectation for the current rating. Should comp growth fail to return to positive territory over the next 12 months, the chain continues to lose share, margin declines persist beyond fiscal 2018 (June), and total adjusted debt/EBITDAR is sustained above 4.0x, a ratings downgrade could occur. The Rating Outlook could be stabilized if comps return to positive territory by 2019, Chili's is able to maintain share, EBITDA margin stabilizes, and Brinker uses FCF to repay debt such that total adjusted debt/EBITDAR remains in the 3.5x to 4.0x range based on Fitch's calculation which capitalizes leases at 8x. KEY RATING DRIVERS Comp Sales, Market Share: Brinker's comps have been negative for two consecutive years, declining 2.1% system-wide for the year ended June 28, 2017, due mainly to declines at Chili's, which has lost share in recent years. Outsized exposure to oil-producing states, missteps with its loyalty program, and general weakness in casual dining have contributed to comp weakness. Fitch expects comps to decline 0.5% in fiscal 2018 and then grow about 1% in fiscal 2019 as Brinker redefines its value proposition, improves restaurant execution, and strengthens takeout capabilities to offer enhanced convenience. Chili's Brand Strength: Chili's represented 97% of Brinker's 1,674 units at June 28, 2017. Brinker is currently investing in the brand to increase the value provided by core menu items, enhance convenience around its takeout platform, and improve in-restaurant execution. Fitch believes Chili's Texas-themed menu differentiates the brand in the highly competitive bar & grill category and that store closures by Applebee's Grill & Bar, one of Chili's direct competitors, could be a benefit. However, Fitch expects low-single digit declines in casual dining traffic to continue until sufficient capacity is taken out of the market and the segment improves its value proposition and convenience relative to limited service competitors. As such, the battle to maintain share or gain share from weaker competitors will cause competition to remain intense over the intermediate term. Margin Stabilization: Brinker's EBITDA margin, excluding non-cash stock-based compensation expense, declined to 14.3% in fiscal 2017 from 15.9% in fiscal 2015 due mainly to declining comps and higher labor costs. While Brinker's restaurant-level profitability remains competitive versus peers, its strategy of investing to enhance its value proposition and upward pressure on labor costs will continue to negatively affect margins in the near term or at least until comp growth returns. Fitch expects EBITDA margin contraction of 50 bps to 13.8% in fiscal 2018 and stabilization thereafter. Moderately High Leverage: Brinker transitioned to a high-yield credit after recapitalizing its balance sheet in September 2016 and is targeting lease-adjusted leverage of 3.25x to 3.75x. This is equivalent to 3.6x to 4.1x based on Fitch's calculation, which capitalizes leases at 8x and excludes non-cash stock-based compensation expense. Fitch projects total adjusted debt/EBITDAR will remain at the high end of Brinker's leverage target or at 4.1x based on Fitch's calculation in fiscal 2018. Leverage sustained above 4.0x could result in a negative rating action. Strong FCF Generation: Brinker generates meaningful FCF. Fitch projects FCF (cash flow from operations less capex and dividends) of approximately $130 million in fiscal 2018 (or approximately $210 million pre-dividend), slightly below an average of $150 million since 2013. Fitch anticipates Brinker will refinance all of its $250 million of 2.6% notes maturing May 15, 2018 and use the majority of FCF towards share buybacks. DERIVATION SUMMARY Brinker's rating is lower than that of its casual dining peer Darden Restaurants, Inc. ('BBB'/Outlook Stable) due mainly to Brinker's leverage being more than 1x higher than Darden's. The rating differential also reflects Brinker's lack of meaningful brand-level diversification, with more than 90% of systemsales from Chili's, and weaker comparable restaurant sales trends. Bloomin' Brands, Inc., a casual dining peer for which Fitch has a credit opinion, and Brinker have similar leverage, but Bloomin's comp growth has been modestly better than that of Brinker. Across Fitch's broader restaurant universe, which includes quick-service restaurant competitors McDonald's Corp. ('BBB'/Outlook Stable), Starbucks Corp. ('A'/Outlook Stable), Restaurant Brands International, Inc., and YUM! Brands, Inc., Brinker's rating reflects its relative leverage and that casual dining is subject to moderately higher economic sensitivity than the quick-service restaurant segment. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: --Comps decline 0.5% in fiscal 2018 and increase 1% in fiscal 2019; --Operating margin declines to 8.7% in fiscal 2018 and stabilizes near this level in fiscal 2019; --FCF (cash flow from operations less capex and dividends) approximates $130 million in fiscal 2018 and $140 million in fiscal 2019; --Total adjusted debt-to-operating EBITDAR rises to 4.1x in fiscal 2018 and declines to 4.0x thereafter. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action Brinker's Rating Outlook could be stabilized if comps return to positive territory by 2019, Chili's is able to maintain market share, EBITDA margin stabilizes in the high 13% range, and FCF is used to repay debt such that total adjusted debt/EBITDAR remains in the 3.5x - 4.0x range. While not anticipated in the near term, ratings could be upgraded if the following occurs: --Consistently positive comps at Chili's and growth in market share; --A commitment to maintain total adjusted debt/operating EBITDAR (defined as total debt plus 8.0x gross rent to operating EBITDA plus gross rent) in the 3.0x-3.5x range. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action --A lack of meaningful improvement in comps and continued loss of market share; --Higher than expected margin contraction; --Capital allocation policies that remain biased toward shareholders; --Total adjusted debt to operating EBITDAR sustained above 4.0x. LIQUIDITY Adequate Liquidity: Brinker's ongoing liquidity is supported by its FCF generation, which Fitch projects can approximate $130 million - $140 million annually, and $1 billion revolving credit facility maturing on Sept. 12, 2021 ($110 million is due on March 12, 2020). On March 29, 2017, Brinker had $598 million available under its revolver, net of $402 million already drawn. The company has maintained a minimal amount of cash on its balance sheet in recent periods. Staggered Debt Maturities: In September 2016, Brinker amended its revolving credit facility, increasing capacity to $1 billion from $750 million and extending the maturity for the majority of the facility to September 2021. The company also issued $350 million of 5% senior unsecured guaranteed notes, the proceeds of which were used to fund $300 million of share repurchases and to repay $50 million of outstanding amounts on the revolving credit facility. Brinker's only maturity over the next three years is $250 million of 2.6% notes due May 15, 2018. Brinker had approximately $1.3 billion of debt inclusive of capital leases at June 28, 2017. All debt is unsecured and issued by Brinker International, Inc., the parent of Brinker Restaurant Corporation and its underlying subsidiaries. A total of $550 million (41%) consisted of unsecured unguaranteed notes, $350 million (26%) were unsecured guaranteed notes and about $400 million (30%) was the outstanding balance on the company's revolver. The remaining $30 million or so (3%) was capital leases. FULL LIST OF RATING ACTIONS Fitch has affirmed Brinker International, Inc.'s ratings as follows: --Long-term IDR at 'BB+'; --Guaranteed senior unsecured bank credit facility at 'BBB-/RR2'; --Guaranteed senior unsecured notes at 'BBB-/RR2'; --Unguaranteed senior unsecured notes at 'BB+/RR4'. Contact: Primary Analyst Carla Norfleet Taylor, CFA Senior Director +1-312-368-3195 Fitch Ratings, Inc. 70 W. Madison St. Chicago, IL 60602 Secondary Analyst Antonio Luiz Gomez Associate Director +1-212-908-1142 Committee Chairperson Monica Aggarwal, CFA Managing Director +1-212-908-0282 Summary of Financial Statement Adjustments - Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below: --Historical and projected EBITDA is adjusted to add back non-cash stock based compensation expense as reported in financials. --Fitch views operating leases as debt-like obligations so capitalizes gross rent expense using a multiple of 8x. 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