Fitch Affirms Staples at 'BB+'; Assigns Stable Outlook

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has affirmed the Long-Term Issuer Default Rating (IDR) for Staples, Inc. (Staples) at 'BB+' and the Short-Term IDR at 'B'. Fitch has removed the Rating Watch Negative following the announced termination of the Office Depot acquisition. The Rating Outlook is Stable.

A full list of rating actions follows at the end of this release.

KEY RATING DRIVERS

Office Depot Merger to be Terminated

Staples and Office Depot announced an intention to terminate their merger agreement on May 16, 2016 following a federal court decision to grant the FTC's request to block the merger on anti-competitive concerns.

Standalone Business Expected to Be Flat at Best

The ratings reflect continued secular headwinds and competitive challenges in the office products category which have pressured EBITDA since 2012. On a standalone basis, Fitch views Staples as having limited ability to reverse declines in sales and EBITDA over the forecast horizon, especially given the heightened threat from new entrants in the contract stationer business.

Staples has fought a number of challenges in recent years, including both secular headwinds and strengthened competition. The ongoing digitalization of the workplace has had a negative impact on sales of core office supplies, ink/toner and paper, which represent around half of Staples volume. Sales of technology products (approximately 20% of sales) have been weak due to a slowing replacement cycle and saturation of key products such as laptops and tablets. Fitch expects both of these headwinds to continue over the forecast horizon.

As sales shift online across many retail categories, new competitors have emerged in the office products category, pressuring in-store sales across the industry. Since 2012, Staples' North American retail sales are down approximately 25% (recently exacerbated by the weak Canadian dollar) and margins of the combined retail/Staples.com business have contracted from 8.3% to 4.5%. As a result, EBITDA contribution has declined nearly 50% from $1.2 billion (57% of total) in 2012 to $650 million (45% of total) in 2015.

Amazon has begun a significant push into office products sales to contract customers, which will limit market share opportunities for existing players. Sales and EBITDA to contract customers have been fairly stable for the last few years, but Fitch expects Staples' competitive positioning could weaken over time.

Staples has undertaken a number of initiatives to combat these challenges. First, the company has reduced its North American store base by around 300 units or over 15% since 2011, with another 50 announced for 2016, to an expected 1,510 by the end of 2016. Second, the company has refocused selling efforts around categories including breakroom and janitorial supplies, which are seeing less secular pressure. Finally, the company has managed its cost structure through the elimination of over $750 million in expenses over the last three years.

The company has announced an additional $300 million cost reduction program to be completed by 2018, and the pursuit of strategic alternatives for Staples' European business, which Fitch estimates is modestly EBITDA negative.

While these efforts have mitigated secular pressures, Staples' sales and EBITDA have declined each year from their respective peaks in 2011 of $25 billion and $2.3 billion. In 2015, $21 billion in sales and EBITDA of $1.4 billion were both 6% below 2014 levels, with EBITDA margin falling to 6.7% from the 2011 peak of 9%. Fitch believes medium-term EBITDA will remain flat at best, likely within the $1.2 billion - $1.4 billion range, as industry challenges persist.

Given the above EBITDA expectations, adjusted leverage is expected to trend in the 3.2x - 3.4x range over the forecast horizon, which Fitch views as representative of a 'BB+' rating for a secularly challenged retailer.

KEY ASSUMPTIONS

--Fitch expects modestly negative annual sales growth over the forecast horizon, based on modestly negative retail/online comps and flattish growth in the commercial delivery business, with EBITDA ranging between $1.2 billion - $1.4 billion on modest margin declines.

--Projected free cash flow (FCF) after dividends of $300 million in 2016 will be used for merger-related debt issuance expenses of $100 million - $150 million and merger breakup fees of $250 million. The company has announced $100 million of share repurchases in 2016 and the company may need to fund this with revolver borrowings or cash on hand. FCF is expected to remain in the $300 million range annually beginning 2017, which Fitch expects will put towards share purchases.

--Adjusted leverage is expected to remain in the 3.2x - 3.4x range.

RATING SENSITIVITIES

Future developments that may, individually or collectively, lead to a negative rating action include continued negative sales and margin trends and declines in EBITDA that drive adjusted leverage above the mid-3x range.

Future developments that may, individually or collectively, lead to a positive rating action include a stabilization of top-line trends, the resumption of positive EBITDA momentum, and maintenance of adjusted debt/EBITDAR at or under 3x.

LIQUIDITY

The company had adequate liquidity at Jan. 30, 2016, comprising of $825 million in cash and full availability on its $1 billion revolving credit facility.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings:

Staples, Inc.

--Long-term IDR at 'BB+';

--$1 billion unsecured revolving credit facility at 'BB+/RR4';

--Senior unsecured notes at 'BB+/RR4';

--Short-term IDR at 'B';

--Commercial paper at 'B'.

The Outlook is Stable.

In addition, Fitch has withdrawn the ratings on the following acquisition-related debt due to the announced termination of the Office Depot merger:

--$3 billion secured revolving credit facility;

--$2.5 billion secured term loan.

Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below:

--Historical and projected EBITDA is adjusted to add back non-cash stock-based compensation and exclude restructuring charges. In 2015, Fitch excluded $38 million in accelerated depreciation and expenses related to its proposed acquisition of Office Depot. Fitch added back $63 million in non-cash stock-based compensation to its EBITDA calculation.

--Fitch has adjusted the historical and projected debt by adding 8x yearly operating lease expense.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Additional Disclosures

Dodd-Frank Rating Information Disclosure Formhttps://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1004325

Solicitation Statushttps://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1004325

Endorsement Policyhttps://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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View source version on businesswire.com: http://www.businesswire.com/news/home/20160511006446/en/

Fitch Ratings
Primary Analyst:
David Silverman, CFA, +1-212-908-0840
Senior Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst:
Monica Aggarwal, CFA, +1-212-908-0262
Senior Director
or
Committee Chairperson:
Philip Smyth, CFA, +1-212-908-0531
Senior Director
or
Media Relations:
Alyssa Castelli, +1-212-908-0540
New York
[email protected]

Source: Fitch Ratings

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