Fitch Cuts Brinker International (EAT) to 'BB+' Following Q4 Results
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Fitch Ratings has downgraded Brinker International, Inc.'s (NYSE: EAT) Long-Term Issuer Default Rating (IDR) to 'BB+' from 'BBB-'. The Rating Outlook is Stable.
The downgrade reflects a shift towards a more aggressive financial policy that Fitch projects will result in leverage (total adjusted debt/EBITDAR) moving up by 0.5x to around 4x in fiscal 2017, versus the previous expectation for leverage to be in the mid-3x in fiscal 2017 and versus 3.4x in fiscal 2016. Brinker announced that it plans to increase leverage in the range of $250 to $300 million in the near term subject to market conditions and use the proceeds to return capital to shareholders in the form of share repurchases. Fitch expects leverage to remain at the heightened level, marking a departure from the company's prior commitment to an investment grade rating.
Brinker's ratings continue to reflect Chili's Bar & Grill's (Chili's) top 3 market position in U.S. casual dining and healthy operating cash flow. Brinker has had a strong track record of positive comp growth, improved profitability, and strong free cash flow (FCF) through fiscal 2015. However, should Fitch project total adjusted debt/EBITDAR being sustained above 4x due to continued negative comps and margin pressures as seen over fiscal 2016, a negative rating action could occur.
A full list of rating actions follows at the end of this release. At fiscal year ended June 29, 2016, Brinker had $1.1 billion of total debt.
KEY RATING DRIVERS
Chili's represented 97% of Brinker's 1,660 restaurants at June 29, 2016; therefore, the strength of the brand is an important indicator of Brinker's credit profile. Brinker strives to keep the brand competitive and relevant in order to maintain share. However, system-wide comps have been negative for four straight quarters, declining 2.2% in the latest quarter and 1.9% for the fiscal year ended June 29, 2016. Fitch views an outsized exposure to oil-producing states, which are experiencing economic weakness, and the transition from direct marketing to the My Chili's Rewards loyalty program as key contributors.
Fitch believes Brinker has done a good job isolating challenges at Chili's. In order to reignite comp growth, Brinker is revamping its loyalty program, increasing marketing spend, enhancing value offerings, and adding more culinary innovation. While gradual improvement is anticipated, comps could remain negative in fiscal 2017 given continued economic weakness in oil-producing states, the highly competitive restaurant environment, and recent declines in restaurant traffic.
Fitch projects total adjusted debt/EBITDAR to increase from the 3.4x for fiscal 2016 to around 4x times in fiscal 2017, given the anticipated debt financed share buybacks.
--Comps decline 1% in fiscal 2017, before returning to positive low single digits;
--Operating margin declines to below 10% in fiscal 2017 and 2018, from 10.7% in fiscal 2016;
--FCF approximates $150 million in fiscal 2017, versus $208 million in fiscal 2016, reflecting EBITDA declining from $506 million to around $460 million to $470 million;
--Total adjusted debt-to-operating EBITDAR rising to around 4x in fiscal 2017, pro forma for incremental debt to fund the $250 million to $300 million in share buybacks.
Future developments that may, individually or collectively, lead to a positive rating action include:
--Consistently positive comps at Chili's with traffic trends at least in line with the industry;
--A commitment to maintain total adjusted debt/EBITDAR in the 3.0x - 3.5x range. This is not anticipated in the near term given the change in financial policy.
Future developments that may, individually or collectively, lead to a negative rating action include:
--A lack of improvement in comps and higher than expected margin contraction;
--Capital allocation policies that remain biased towards shareholders, despite weak operating performance and increased leverage;
--Total adjusted debt/EBITDAR sustained above 4.0x.
At June 29, 2016, Brinker had $31 million of cash. Available under its $750 million revolver due to mature March 12, 2020 was $160 million at March 23, 2016. Brinker's nearest upcoming maturity is the $250 million 2.6% notes due 2018, which Fitch anticipates will be refinanced.
Fitch projects Brinker will generate roughly $150 million in fiscal 2017, versus $208 million in fiscal 2016. Capex is expected to approximate $110 million - $120 million in fiscal 2017, versus $113 million in fiscal 2016. Dividends are projected to track Brinker's 40% of earnings payout target. Most of the company's FCF is expected to be used for share repurchases.
Fitch has downgraded the existing $750 million credit facility and $550 million of senior unsecured notes to 'BB+' from 'BBB-' and assigned Recovery Ratings (RR) of RR4, indicating average recovery prospects. Fitch expects Brinker will have to amend its credit facility to allow for incremental leverage (given a maximum leverage of 3.5x based on capitalizing leases at 6x rent). Should the amended credit facility and/or any new notes to fund the share buybacks be given priority either through security or guarantees, the ratings on the amended credit facility and/or new notes could potentially be notched up from current levels.
FULL LIST OF RATING ACTIONS
Fitch has taking the following rating actions on Brinker:
--Long-term IDR downgraded to 'BB+' from 'BBB-';
--Senior unsecured bank credit facility downgraded to 'BB+/RR4' from 'BBB-';
--Senior unsecured notes downgraded to 'BB+/RR4' from 'BBB-'.
The Rating Outlook is Stable.
The assignment of the RRs reflects Fitch's 'Recovery Ratings and Notching Criteria for Non-Financial Corporates issuers' criteria dated April 5, 2016, which allows for the assignment of Recovery Ratings for issuers with IDRs in the 'BB' category.
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