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S&P Drops Quad/Graphics (QUAD) to 'BB-'; Cites Increased Adjusted Leverage

April 7, 2014 2:22 PM EDT
Standard & Poor's Ratings Services today lowered its corporate credit rating on Sussex, Wis.-based printing company Quad/Graphics Inc. (NYSE: QUAD) to 'BB-' from 'BB'. The outlook is stable.

At the same time, we assigned the company's proposed $1.6 billion senior secured credit facility a 'BB-' issue-level rating, with a recovery rating of '3', indicating our expectation for meaningful (50%-70%) recovery in the event of a payment default. The facility consists of an $850 million revolving credit facility due 2019, $450 million term loan A due 2019, and $300 million term loan B due 2021.

In addition, we assigned the company's proposed $300 million senior unsecured notes a 'B' issue-level rating, with a recovery rating of '6', indicating our expectation for negligible (0% to 10%) recovery in the event of a payment default.

The downgrade reflects the increase in adjusted leverage beyond our 3x threshold for the company at a 'BB' rating, where we expect it will remain as the company combats low- to mid-single-digit percent annual organic revenue declines, amid long-term structural declines in most of its end markets. As of Dec. 31, 2013, Quad's adjusted leverage was 3x. However, pro forma for the refinancing and acquisition of Brown Printing Company, adjusted leverage increased to roughly 3.2x. Additionally, the company's operational pressures have not subsided as organic revenue declined about 4.5% in 2013 and the adjusted EBITDA margin fell to 11.6% from 12.3% in 2012. Given the increase in adjusted leverage and declining operating fundamentals, we revised our financial risk profile assessment to "significant" from "intermediate," indicating increased risk.

We view Quad's business risk profile as "weak." The company's print products are well-diversified, but the majority of its end markets, including books, magazines, retail inserts, and directories face unfavorable structural changes as content and advertising dollars shift to digital media. These trends have caused printing volumes to decline, which in turn has resulted in lower industry capacity utilization and aggressive pricing tactics by market participants that have eroded profitability.

Quad's non-print revenue consists mostly of its logistics segment, which accounts for about 10% of total revenue. The company has undertaken marketing solutions initiatives for its clients, but we do not expect those efforts to drive incremental revenue in the short term. We view Quad's management and governance as "fair."

We view Quad's financial risk profile as "significant," based on our pro forma adjusted leverage calculation of 3.2x. As of Dec. 31, 2013, Quad's adjusted leverage (which includes adjustments for pension and operating leases) was 3x, only just meeting our threshold for adjusted leverage for the company at the "intermediate" financial risk profile. We expect the company to reduce debt through cash contributions to the underfunded pension and post-retirement liability and through debt amortization payments in 2014 and 2015. At the same time, we also expect that declines in EBITDA resulting from the organic decline of the business will offset debt reduction, keeping adjusted leverage over 3x.


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