Fitch Ratings has affirmed the ratings of DineEquity, Inc. (NYSE:DIN) as follows:
--Long-term Issuer Default Rating (IDR) at 'B';
--Senior secured bank credit facility at 'BB/RR1';
--9.5% senior unsecured notes at 'B+/RR3'.
The Rating Outlook is Stable.
At March 31, 2012, DineEquity had approximately $1.6 billion of total debt.
DineEquity's ratings reflect the company's high financial leverage, consistent free cash flow (FCF) generation, and on-going business strategy. The firm's primary focus is to grow same-store sales (SSS), reduce debt, and refranchise company-operated restaurants. DineEquity's scale and competitive U.S. position of over 2,000 Applebee's and 1,500 IHOP units are also incorporated into ratings.
DineEquity's credit profile is enhanced by the stable source of royalty-based revenue and high level of profitability provided by its growing mix of franchised restaurants. The company's goal is to become 99% franchised across the Applebee's and IHOP system. At Mar. 31, 2012, DineEquity was 95% franchised on a combined system basis.
Fitch believes DineEquity can achieve its refranchising goal over the next couple of years due to the recent pace of transactions and views the company's franchise system as being in good shape. DineEquity has not experienced any material issues with the collection of royalties, franchisees have financed the remodeling of restaurants, and many existing franchisees have purchased units sold by the firm.
On May 1, 2012, the firm announced an asset-purchase agreement to sell 39 of its 160 company-operated Applebee's units to Potomac Family Dining Group, LLC - an existing franchisee. The transaction is expected to close in the third quarter of 2012. Net after-tax proceeds will be approximately $25 million and the financing obligation associated with the 2008 sale-leaseback of 181 Applebee's properties will decline by about $40 million. As of Dec. 31, 2011, DineEquity's continuing involvement with 80 of the 181 properties ended by the assignment of lease obligations to qualified franchisees or a release from the lessor.
The 'RR1' recovery rating on DineEquity's secured bank facility reflects Fitch's view that recovery prospects for this debt are outstanding and would exceed 90% in a distressed situation. The 'RR3' rating on the firm's 9.5% senior unsecured notes incorporates Fitch's opinion that bondholders would recover between 51% - 70% of principal in a distressed scenario. DineEquity's fairly balanced mix of secured priority debt and unsecured notes improves recovery prospects for bondholders.
Credit Statistics and Rating Triggers:
DineEquity's credit statistics are in line with Fitch's expectations. Leverage continues to gradually decline but remains high because debt pay down has been partially offset by the EBITDA give up associated with refranchising company-operated units. For the latest-twelve-month (LTM) period ended March 31, 2012, rent-adjusted leverage (defined as total debt plus 8 times gross rent-to-operating EBITDA plus gross rent) was 6.2 times (x). Operating EBITDAR-to-Gross Interest Expense plus rent was 1.7x and FFO Fixed Charge Coverage was 1.6x. The company generated $89.2 million of FCF and had an EBITDA margin of 28.9%. Fitch does not include receipts from long-term receivables in its FCF calculation.
Fitch believes DineEquity is capable of reducing leverage by up to 1.0x within the next 24 months as the firm continues to utilize internally generated cash and refranchising proceeds to reduce debt. Since 2008, FCF has averaged roughly $100 million annually and after-tax refranchising proceeds have totaled over $170 million. When including the reduction in the firm's financing obligation, total debt has declined by nearly $800 million to $1.6 billion over the same period.
An upgrade of DineEquity's IDR could occur if rent-adjusted leverage declines to the mid-5.0x range due to SSS growth, stable or improving FCF generation, and continued debt reduction. Conversely, the firm's IDR would be lowered if there is a material increase in leverage, due to a shift in financial strategy, substantial declines in FCF and/or persistently negative SSS performance. Changes in recovery ratings would be driven by sustained increases or decreases in EBITDA, material debt reduction, or changes in the firm's capital structure.
Same-Store Sales Performance:
Fitch views DineEquity's 2012 SSS guidance as reasonable, given the extremely competitive nature of the U.S. restaurant industry and gradually declining high U.S. unemployment rate. The firm expects SSS growth at Applebee's to range between 0.5% and 2.5% while SSS performance at IHOP is projected to range between negative 1.5% and positive 1.5%. During the first quarter ended Mar. 31, 2012, SSS increased 1.2% at Applebee's but fell 0.5% at IHOP. Traffic at both brands was modestly negative.
Applebee's strategy to drive sales is to frequently update core menu items, the brand's 2 for $20 and Great Tasting Under 550 calories platforms, and to continue initiatives around the late-night day part. Efforts to improve sales trends at IHOP consist of changes to the brand's promotional strategy, including its recently launched 7 for $7 platform and reduced emphasis on limited time offers. DineEquity is also working with franchisees to improve service quality.
Liquidity, Maturities and Financial Covenants:
DineEquity's liquidity is adequate given the firm's FCF and limited near-term maturities. Furthermore, the cash needs of a highly franchised system are minimal as franchisees self-finance unit development and remodeling requirements. At March 31, 2012, DineEquity had $110 million of liquidity consisting of $48.7 million of cash and $61.2 million availability, excluding $13.8 million of letters of credit, on its $75 million revolver expiring Oct. 19, 2015.
At March 31, 2012, scheduled maturities of long-term debt were immaterial until Oct. 19, 2017 when the remaining $612.0 million balance on DineEquity's term loan becomes due. The term loan amortizes at 1% of original principal annually. DineEquity's 9.5% notes, which have a remaining balance of $760.8 million, mature on Oct. 30, 2018.
Financial covenants in DineEquity's secured credit facility include a maximum consolidated leverage ratio (defined as total indebtedness minus no more than $75 million of cash-to-EBITDA) and a minimum interest coverage ratio. The maximum leverage ratio is 7.25x in 2012 but steps down 0.25x annually through 2016 to 6.0x. The minimum coverage ratio is 1.5x in 2012, stepping up 0.25x in 2013 and then again in 2016. At March 31, 2012, the ratios were 5.2x and 2.4x, respectively. Fitch estimates that EBITDA would have to decline by approximately 30% or more to breach these covenants.
DineEquity's senior unsecured notes do not have financial covenants but contain a Negative Pledge clause that requires equal and ratable security if non-permitted secured debt is incurred and have a change of control put option at 101% of principal plus accrued and unpaid interest.
Additional information is available at 'www.fitchratings.com'. The ratings above were unsolicited and have been provided by Fitch as a service to investors. The ratings above have been initiated by Fitch as a service to investors. The issuer did not participate in the rating process other than through the medium of its public disclosure.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 12, 2011).
--'2012 Outlook: U.S. Restaurants - Credit Risk Is Chiefly Contained As Sales Will Grow but Food Costs Remain Elevated' (Dec. 7, 2011).
Applicable Criteria and Related Research:
Corporate Rating Methodology
2012 Outlook: U.S. Restaurants