News Column

Fitch Downgrades Staples' IDR to 'BBB-'; Outlook Negative

May 2, 2014

CHICAGO--(BUSINESS WIRE)-- Fitch Ratings has downgraded its long-term Issuer Default Rating (IDR) on Staples, Inc. to 'BBB-' from 'BBB', and its short-term IDR to 'F3' from 'F2'. The Rating Outlook is Negative. As of Feb. 1, 2014, Staples had $1.1 billion of debt outstanding. A full list of rating actions is shown below.

KEY RATING DRIVERS

The downgrade reflects Staples' weak sales and margin trends caused by a secular decline in sales of core office supplies (57% of Staples' 2013 sales, half of which is paper, ink and toner), and weak sales of business technology products (15% of sales). Declining operating performance also reflects competition from online retailers, persistent weakness in the company's international segment, and the challenging macroeconomic environment. The Negative Outlook reflects Fitch's view that these trends could persist over the medium term.

The rating continues to be supported by Staples' leadership position in the mature retail and commercial office product supply industry, a diversified model by channel and customer, and strong free cash flow (FCF). The ratings also reflect the benefit from Staples' cost reductions that will fund sharper pricing investments in the business and the rationalization of the sector's retail square footage with significant store closings anticipated between Staples and Office Depot.

Staples has leading positions in its two largest segments - North American Stores and Online and North American Commercial, which accounted for 54% and 41%, respectively, of EBITDA in 2013. The international segment, which is centered in Europe, faces significant challenges and represents only 5% of EBITDA.

The company's operating trends over the past 24 months have been soft, with sales down 3.4% in 2013 (excluding the extra week in 2012) following a 3% decline in 2012. Within the North American Stores and Online segment, 2013 sales declined 4.3% due to a 4% drop in North American retail comps and the effect of net store closures (40 stores closed in 2013 and 31 in 2012) and downsizings, offset in part by low single digit growth at Staples.com. International sales were down a sharp 9% in 2013 (excluding the extra week in 2012) and 11.8% in 2012, due to sales declines in Europe and Australia and the negative impact of foreign exchange rates.

The North American commercial segment has been more stable over time from a top line perspective, growing at a 1%-2% pace annually, including a 1.2% increase in 2013 excluding effect of the extra week in 2012, and Staples has stepped up investments in the business to support continued growth.

The deceleration in retail top line and investments to drive growth in the North American business have resulted in EBITDA contraction of over 20% to $1.8 billion since 2011. The EBITDA margin declined to 7.7% in 2013 from 8.75% in 2012 and over 9% in 2011.

With more than 70% of Staples' product mix under secular pressure, Fitch expects consolidated top line to contract by 3% annually in 2014 and 2015. As a result, EBITDA is expected to decline to $1.5 billion to $1.6 billion in 2014/2015 and EBITDA margins are expected to contract by another 60 basis points (bps) to 80bps to below 6.9%-7%.

In the wake of soft 2013 results, Staples has accelerated its restructuring efforts, announcing in March 2014 its plan to close up to 225 stores in North America and reduce costs by $500 million by the end of 2015. The cost reductions, which will be achieved through supply chain improvements, retail store closures and other areas, will be reinvested in Staples' prices, marketing and website to drive traffic and sales. These investments are likely to pressure margins over the near term but could potentially help mitigate top-line pressure longer term.

Fitch expects that the planned store closings and downsizings could stabilize or modestly improve store productivity trends. Together with expected store closings at Office Depot, these closings will help to rationalize the sector's retail footprint. Fitch estimates that annual sales per square foot in Staples' North American stores will recover from around $250 in 2013 to around $260 over the next two years, but remain well below pre-recession peak sales per square foot of $330 to $350.

Staples had cash and cash equivalents of $493 million as of Feb. 1, 2014 and an unused $1 billion revolving credit facility expiring in May 2018. Its nearest debt maturity is a $500 million note issue due in January 2018.

FCF after dividends has been consistently positive, though it has trended lower to the $400 million range versus $800 million to $900 million in 2010/2011. The company has used its FCF in part for debt reduction, enabling adjusted debt/EBITDAR to remain steady at around 2.9x even as EBITDA has declined.

With no near-term debt maturities, debt levels are expected to remain flat and FCF is expected to be used primarily for share repurchases. Fitch expects adjusted leverage to increase to the low 3x range in 2014 on its projected EBITDA decline.

RATING SENSITIVITIES

Future developments that may, individually or collectively, lead to a Stable Outlook include a stabilization of top-line and EBITDA trends, and maintenance of adjusted debt/EBITDAR at or under 3x.

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 towards the mid-3x area.

Fitch has downgraded the following:

Staples, Inc.

--Long-term Issuer Default Rating (IDR) to 'BBB-' from 'BBB';

--Bank credit facility to 'BBB-' from 'BBB';

--Senior unsecured notes to 'BBB-' from 'BBB';

--Short-term IDR to 'F3' from 'F2';

--Commercial paper to 'F3' from 'F2'.

The Rating Outlook is Negative.

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

Applicable Criteria and Related Research:

--Corporate Rating Methodology, Aug. 5, 2013.

Applicable Criteria and Related Research:

Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139

Additional Disclosure

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.



Fitch Ratings

Primary Analyst:

Philip M. Zahn, CFA

Senior Director

+1 312-606-2336

Fitch Ratings, Inc.

70 W. Madison Street

Chicago, IL 60602

or

Secondary Analyst:

Monica Aggarwal, CFA

Senior Director

+1 212-908-0262

or

Committee Chairperson:

Bill Densmore

Senior Director

+1 312-368-3125

or

Media Relations:

Brian Bertsch, New York, +1 212-908-0549

brian.bertsch@fitchratings.com

Source: Fitch Ratings


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