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Fitch Affirms Lion/Seneca France 2 at 'B'; Outlook Stable
May 28, 2015 / 4:37 PM / 3 years ago

Fitch Affirms Lion/Seneca France 2 at 'B'; Outlook Stable

(The following statement was released by the rating agency) FRANKFURT/LONDON, May 28 (Fitch) Fitch Ratings has affirmed France-based optical retailer Lion/Seneca France 2 S.A.S.'s (Afflelou) Long-term Issuer Default Rating (IDR) at 'B'. The Outlook is Stable. Fitch has also affirmed 3AB Optique Developpement S.A.S.'s EUR365m senior secured notes due 2019 and super senior revolving credit facility (RCF) ratings at 'BB-'/'RR2' and Lion/Seneca France 2 S.A.S.'s EUR75m senior notes due 2019 rating at 'CCC+'/'RR6'. The rating reflects Afflelou's robust earnings and cash flow generation despite the challenging operating environment in France. The intrinsic stability of the issuer's business model is due to the favourable reimbursement policy in France, making optical products less price sensitive for consumers. We see little risk of weakening commercial quality as long as volume risks can be addressed through the expansion of the store network activity and the price elasticity of Afflelou's French operations, which account for 78% of total network sales, remains low with no material curtailments in the national reimbursement rates. KEY RATING DRIVERS Consolidation of Market Position Afflelou continues to adapt its business strategy to the challenging economic environment in France and leverage its position with suppliers. We expect overall negative organic network activity for FY15 supported by acquisitive growth outside France. Projected positive sales dynamics from FY16 onwards remain subject to the accretive impact of the care networks and further add-on acquisitions. Operating margins are forecast at around 22% sustainably, driven by the supplier mix and the continuously high share of the directly owned stores. Contained Impact of DOS The strong increase in the share of revenues generated by directly owned stores (DOS) has a credit dilutive impact as it weakens earnings and margins. It also brings higher capital requirements and additional debt-like rental obligations to the otherwise asset light business model. We do not expect a tangible reduction from DOS over the rating horizon, but project that they will have a relatively contained impact on the company's credit quality given Afflelou's strategic preference to concentrate on the franchisee network organically and by acquisition. Neutral Effect from Regulatory Changes We expect the recently passed regulatory changes to have a largely neutral effect on Afflelou's commercial risk. The brand's strategic repositioning towards national care networks should result in an expanded customer base and higher volumes, already observed in 2Q15. At the same time, an increased market transparency is likely to intensify price competition among optical retailers and exert pressure on margins. Acquisitions Embedded in Rating Based on Afflelou's recently completed add-on acquisition and its M&A pipeline, the company is likely to continue looking for external expansion opportunities. We have therefore included an annual acquisition budget of EUR10m for FY15 and FY16. Our projections are based on Afflelou's generating positive free cash flows with a margin sustainably above 8%, which would comfortably accommodate add-on acquisitions from internal cash reserves without constricting Afflelou's financial flexibility and liquidity position, and without weakening its overall credit profile. Robust Cash Flow Generation Compared with other healthcare and retail peers, Afflelou has generated relatively high funds from operations (FFO) margins and positive free cash flow (FCF) margins, despite the challenging operating environment in France. We expect this trend to continue with a growing cushion to our downgrade sensitivity threshold of 8% for the FCF margin, driven by EBITDA-led FFO expansion and low capex nature of the franchisor business model. Leverage Commensurate with Rating Our peer analysis against other Fitch-rated healthcare credits suggest that Afflelou's FFO adjusted leverage is comfortably positioned in the 'B' rating category, demonstrating a similar de-leveraging trajectory towards 6.0x in FY17. In contrast, traditional retailers of the same credit quality do not tolerate leverages above 6.0x, which is due to the intrinsically higher volatility of their earnings and cash flows. Superior Recoveries for Senior Secured Creditors We consider that the distressed valuation of the company would be maximised in a going concern scenario as the business is fairly asset-light (franchisor business model). In addition, we believe that should Afflelou default, this would not be the result of a broken business model but rather due to an adverse regulatory change (reimbursement policy) or unmanageable financial leverage. We have reduced the discount to 15% from 20% and applied it to January 2015 LTM EBITDA of EUR70m leading to a post-restructuring EBITDA of EUR.60m. This remains the appropriate sustained post-restructuring earnings estimate, in our view, given Afflelou's sustained post-restructuring cash outlays. We maintained the distressed EV/EBITDA multiple at 5.5x in line with 'B' category peers in the sector. Our analysis results in superior recovery prospects for both the super senior RCF (capped at 90% due to the French jurisdiction) and senior secured notes at 'RR2' and very limited recovery prospects for the senior notes at 'RR6'. We note however that with the estimated recovery rate of RR2/72% the senior secured notes are positioned at the very low end of the RR2 band (71-90%), and any further sustained deterioration in EBITDA may result in a negative outlook for the IDR, leading to a senior secured notes downgrade. Fitch notes that the convertible bond held at the level of Lion/Seneca Lux 2 is treated as 100% equity and is excluded from the debt calculation. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for Afflelou include: - Low single digit organic sales growth rates. - Acquisitive annual sales expansion of EUR7m-EUR14m in FY15-17. - EBITDA margin sustainably at 22.3%. - Capex at EUR10m p.a. - Annual acquisition budget of EUR10m in FY15 and FY16, funded from internal cash reserves. RATING SENSITIVITIES Positive: Future developments that could lead to positive rating action include: - Stable to improving EBITDA margin driven by stable to expanding network activity and no negative impact from regulatory changes - FFO gross adjusted leverage below 5x - FFO fixed charge cover improving towards 2.5x. Negative: Future developments that could lead to negative rating action include: - Deterioration of EBITDA and FCF margins as a result of continued weak network activity, impact of regulatory changes, adverse supplier mix changes or further material increase of the DOS segment - FFO gross adjusted leverage above 7x or no evidence of deleveraging, for example because of operating underperformance or on-going acquisition activity - Any sign that internet is becoming a serious threat, reflected in negative like-for-like sales growth on a sustained basis - Unsuccessful integration of new material acquisition/s - FFO fixed charge cover of 1.8x or below.. These ratios are based on Fitch-calculated metrics. LIQUIDITY Sufficient Liquidity Afflelou is projected to remain cash generative with annual FCF generation of around EUR30m-EUR35m, provided no further substantial net additions of DOS is taking place as in FY14. These levels of organic liquidity can accommodate small acquisitions of up to EUR10m p.a. without compromising its financial flexibility. Given Afflelou's position of a payment intermediary between suppliers and stores and by using Dailly assignments, a simplified form of receivables assignments, its working capital exposure is relatively short, mostly on an intra-month basis. In addition, the company can resort to the currently undrawn RCF of EUR30m due November 2018. Business Accommodating Debt Package Following the issuance of the notes in 2014, Afflelou faces no short-term refinancing risk. Its back-ended, although concentrated debt structure with both notes maturing in April 2019, bears no interest rate risk and allows for a reasonable operational flexibility, given the presence of only one springing covenant under the RCF with min EBITDA level. However, due to Afflelou's highly leveraged capital structure, its financial flexibility is limited. FULL LIST OF RATING ACTIONS 3AB Optique Developpement S.A.S. --Super senior RCF 'BB-'/RR2/90% --Senior secured notes 'BB-'/RR2/72% Lion/Seneca France 2 S.A.S --Senior notes 'CCC+'/RR6/0% Contact: Primary Analyst Elena Stock Director +49 69 76 80 76 135 Fitch Deutschland GmbH Neue Mainzer Strasse 46-50 D-60311 Frankfurt am Main Secondary Analyst Patrick Durcan Analyst +44 20 3530 1298 Committee Chairperson Deborah Ogawa Senior Director +44 20 3530 1743 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014) here Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 18 Nov 2014) here Additional Disclosures Solicitation Status here <a href="https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context =2&detail=31">Endorsement Policy ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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