Moody's Upgrades HD Supply Holdings (HDS) to 'B1'; Outlook Positive

Moody's Investors Service upgraded HD Supply, Inc.'s (Nasdaq: HDS) Corporate Family Rating to B1 from B2, and its Probability of Default Rating to B1-PD from B2-PD as well. In related rating actions, Moody's upgraded the senior secured debt to Ba3 from B1 and the unsecured notes to B3 from Caa1. Moody's also assigned a B3 to the company's proposed $1.0 billion senior unsecured notes due 2024, which will have substantially the same terms and conditions as the existing $1.275 billion Senior Unsecured Notes due 2020, and rank pari passu to each other in a recovery scenario. Proceeds from the notes issuance and about $124 million of cash on hand will be used to refinance the company's existing $1.0 billion senior unsecured notes due 2020 (at which time the ratings for these notes will be withdrawn), and to pay related fees, expenses and make-whole premium. Moody's raised the Speculative Grade Liquidity Rating to SGL-1 from SGL-2 as well. The rating outlook is positive.

The following ratings/assessments were affected by this action:

Corporate Family Rating upgraded to B1 from B2;

Probability of Default Rating upgraded to B1-PD from B2-PD;

1st lien Term Loan due 2021 upgraded to Ba3 (LGD3) from B1 (LGD3);

1st lien Senior Secured Notes due 2021 upgraded to Ba3 (LGD3) from B1 (LGD3);

Senior Unsecured Notes due 2020 upgraded to B3 (LGD5) from Caa1 (LGD5);

Senior Unsecured Notes due 2024 assigned B3 (LGD5).

Speculative Grade Liquidity Rating raised to SGL-1 from SGL-2.

RATINGS RATIONALE

The upgrade of HDS' Corporate Family Rating to B1 from B2 reflects our expectations that operating profits and cash flow generation will continue to grow organically, driven mainly by higher volumes across its businesses, and credit metrics will continue to improve. Over the next 12-18 months, Moody's projects HDS's operating margins nearing 11% from 10.4% for FY15 ended January 31, 2016. Moody's expects interest coverage (measured as EBITA-to-interest expense) approaching 2.5x compared to 1.8x for FY15 and debt leverage improving to at least 4.5x over the next 12-18 months from 4.7x at FYE15.

Moody's anticipates gains coming from all lines of business, especially from Facilities Maintenance. This business, driven mainly by maintenance, repair and operation (MRO) needs, is the company's largest and most profitable, representing slightly less than 40% of total revenues. The relatively constant demand for supplies and services needed to maintain and upgrade multifamily, hospitality, healthcare and institutional facilities is a source of stable earnings and potential growth as institutions increase operating budgets, and multifamily vacancies decline.

The raise in HDS' Speculative Grade Liquidity Rating to SGL-1 from SGL-2 results from Moody's expectations of higher levels of free cash flow, reducing reliance on the company's revolving credit facility. Moody's anticipates free cash flow will be used to pay off all revolver borrowings used for working capital needs, resulting in substantial revolver availability by year-end.

The positive rating outlook reflects our expectation that HDS will continue to follow conservative financial policies, apply cash flow to debt reduction, and key credit metrics will further improve over the next 12 to 18 months.

Moody's views the proposed notes issuance as a credit positive, because it lowers cash interest payments and staggers and extends the company's maturity schedule. Anticipated cash interest savings could approach nearly $60 million per year. The benefits are partially mitigated by the make-whole premium triggered by calling existing notes and related fees, resulting in a cash break-even point in mid-2018. Cash interest payments are now projected to be around $265 million, significantly lower than the peak of $620 million in fiscal 2012. Also, the refinancing reduces the company's refinancing risks in 2020, when the company would have had a wall of debt totaling $2.275 billion coming due. Now HDS needs to contend only with its $1.275 billion senior unsecured notes in that year.

Ratings could be upgraded if:

» Adjusted Debt-to-EBITDA is sustained below 4.0x (4.7x at FYE15)

» The company continues to generate healthy free cash flow and apply it to permanent debt reduction

Ratings could be downgraded or the outlook revised to stable if:

> HDS' operating performance falls below expectations or the company deviates from conservative financial policies.

» Adjusted Debt-to-EBITDA exceeds 5.5x

» EBITA-to-interest expense remains below 2.0x (1.8x for FY15)

» Significant deterioration in the company's liquidity profile

» Sizeable share repurchases

» Large debt-financed acquisitions

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