We think it likely that U.K. inflationary pressure in financial year 2011 will
have been offset by management’s tight cost controlling measures. The
company’s membership-based operating model for its individual membership (IM)
business has continued to exhibit very limited cyclicality, supported by the
fact that more than three-quarters of customers renew their policies annually.
The corporate partnership (CP) business, which accounts for nearly 40% of
annual breakdown sales, won several new mandates in 2011, which largely offset
business lost in 2009. We anticipate that RAC’s insurance broking business
will begin to generate stronger results as it matures and increases in scale.
RAC is the U.K.’s second-largest provider of car breakdown and roadside
assistance services, with a low-risk membership-based operating model,
national scale, and strong U.K. brand recognition. The company has relatively
limited exposure to macroeconomic cycles and benefits from high barriers to
entry.
SP base-case operating scenario
In our current base-case operating scenario, we anticipate that RAC will
achieve mid-single-digit revenue growth in the financial year-ending Dec. 31,
2012. The company has been developing and strengthening its sales force, which
should support organic revenue growth. At the same time, we also anticipate
that Standard Poor’s-adjusted EBITDA will grow to more than GBP110 million.
SP base-case cash flow and capital-structure scenario
The company generates strong flows and has good potential to deleverage more
rapidly than expected. We anticipate that, from time to time, the company may
be able to make unscheduled debt repayments and that during financial year
2012, RAC’s adjusted debt to EBITDA will improve to less than 9x (including
shareholder loans) from just more than 10x, which we forecast for Dec. 31,
2011. We forecast that adjusted funds from operations (FFO) will improve
slightly but remain between 5% and 10% in the year to Dec. 31, 2012.
We anticipate that, in the medium term, leverage metrics may be pressured as a
result of the accrual of payment-in-kind (PIK) on the shareholder loans, which
may potentially outpace EBITDA growth. We treat the interest-accruing
shareholder loans as debt under our criteria. We do however note that accrual
of interest is PIK, not cash, which is a positive cash flow factor for the
company in the short to medium term.
We forecast that the company will remain cash flow positive and that FFO will
be between GBP60 million and GBP70 million on Dec. 31, 2012.
Liquidity
We assess RAC’s liquidity as “adequate” under our criteria. We anticipate that
liquidity sources, including FFO, will exceed uses by more than 2x in
financial year 2012.
We forecast that liquidity sources will be about GBP120 million in 2012,
including:
– GBP50 million under an undrawn committed revolving credit facility
(RCF), maturing 2015;
– GBP60 million to GBP70 million of FFO; and
– Modest inflows from improvements in working capital.
We estimate that RAC’s liquidity needs in 2012 will be about GBP60 million,
including:
– Capex in the region of GBP5 million to GBP10 million; and
– Unscheduled debt repayments of up to GBP50 million.
RAC has negligible annual debt repayments before 2017. Following the group’s
refinancing in 2011, we believe that headroom under the proposed covenants is
likely to remain adequate in the near to medium term.
Recovery analysis
The issue rating on RAC’s GBP50 million RCF, GBP50 million capital expenditure and
restructuring facility, and GBP520 million term loan B facility (together, the
senior facilities) is ‘B+’, in line with the corporate credit rating. The
recovery rating on these facilities is ’3′, indicating our expectation of
meaningful (50%-70%) recovery in the event of a payment default.
The recovery rating is underpinned by unconditional guarantees from all
material subsidiaries (representing at least 80% of EBITDA and gross assets),
and by our favorable view of the U.K. jurisdiction from a creditor
perspective. At the same time, the recovery rating is constrained by limited
freehold asset backing, the fact that the majority of assets pledged are
intangibles, and a security package for the senior facilities that only
includes a pledge on the nonregulated assets of operating subsidiaries RAC
Financial Services and RAC Motoring Services, which are modest in value.
The senior debt facilities incorporate tightening financial covenants and only
modest debt incurrence baskets.
In order to determine recovery prospects, we simulate a hypothetical default
scenario. Our default scenario assumes that greater competitive pressures
could result in the loss of key corporate contracts, which, combined with
potentially higher costs, could put pressure on revenues and lead to a default
in 2015.
Given the strength of the group’s brand and substantial customer portfolio, we
value RAC on a going-concern basis. We primarily use a market multiple
approach, with an EBITDA multiple of 6.1x at the point of default, based on
our analysis of peers with similar business risk profiles. On this basis, we
determine a stressed enterprise value of about GBP420 million at our simulated
point of default. After deducting GBP21 million of enforcement costs, this
leaves about GBP400 million for the senior secured debtholders. Including
prepetition interest, the senior secured facilities amount to about GBP650
million, which translates into meaningful recovery of about 50% to 70%.
Outlook
The stable outlook reflects our opinion that, even taking a conservative view
of future growth prospects, RAC should be able to maintain the financial
flexibility necessary to service its newly highly-leveraged debt structure.
This reflects the group’s solid operating track record, positive free cash
flow generation, and our view of the stability of its individual membership
business model. The outlook also reflects the absence of near-term refinancing
challenges, provided that the group maintains adequate headroom under its
tightening financial covenants.
We could lower the ratings if poor trading were to weaken the group’s
liquidity position such that headroom under financial covenants fell to less
than 10%, EBITDA cash interest coverage fell to less than 3x, or if funds from
operations to net debt (adjusted for leases and the shareholder loan) fell to
less than 5%.
Ratings upside is possible in the medium term, in our view, if RAC maintains
steady debt deleveraging (to less than 5x including the shareholder loan).
However, we do not anticipate this to be a material change unless the
shareholder loan is replaced with common equity.
Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit
Portal, unless otherwise stated.
– Criteria Methodology: Business Risk/Financial Risk Matrix Expanded,
May 27, 2009.
– 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
– 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
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