O'Reilly Automotive (ORLY) Raised to 'BBB+' by S&P; Outlook Stable

January 26, 2015 1:02 PM EST

Standard & Poor's Ratings Services today raised all of its ratings on Springfield, Mo.-based O'Reilly Automotive Inc. (Nasdaq: ORLY), including the corporate credit rating, which we raised to 'BBB+' from 'BBB'. The outlook is stable.

"The upgrade reflects our positive reassessment of O’Reilly’s business risk profile to "strong" from "satisfactory" based on the company’s competitive position in the auto parts retail industry and solid historical profit growth and future prospects. The company has experienced industry leading sales and profit growth for some time, which we believe is driven by its strong customer service and distribution capabilities in its commercial, do-it-for-me (DIFM) business," said credit analyst Samantha Stone. "We believe this market will moderately outpace growth in the retail, do-it-yourself (DIY) industry, and O’Reilly is well positioned to capitalize on that industry growth. Still, we believe its DIY business could perform well over the near term, especially if we experience severe winter conditions this year that could lead to greater part failures throughout 2015. In addition, we expect miles driven in the U.S. to increase because of declining fuel prices and scrappage rates to remain low, keeping average car age relatively steady despite strong new car sales."

The stable outlook reflects our expectation that the company’s operating momentum will continue over the near term and will generally outpace industry peers. We forecast credit metrics to remain in line with the financial risk profile, assuming that the company will reach its stated leverage target of 2.0x to 2.25x (currently the company is slightly lower than that at 1.9x as of the third quarter). Over time, we expect the company to reach its leverage target with increased debt, and with our adjustments, we expect O'Reilly to have adjusted debt to EBITDA between 2.2x and 2.5x.

Downside scenario

We believe a downgrade is unlikely over the next two years given our assumptions and the company's current financial policies. However, if the company changed its financial policies such that our adjusted leverage was approaching 3.0x and FFO/debt was in the low 20% area. At that time, we would reassess the company's financial risk profile as "significant". In this scenario, O'Reilly would have to add about $1.5 billion of debt to reach that threshold.

Upside scenario

Although unlikely, a positive rating action would be driven by the company changing its financial policy such that it would maintain a long term target leverage of 1.8x or better. This would approximate to leverage of 2.0x with our adjustments and align with a "modest" financial risk profile. Along with an enhanced credit protection profile, an upgrade is also predicated on the business continuing to outperform our expectations, leading to scale and diversification that would be comparable or better than its peers.

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