KEY RATING DRIVERS
The affirmation of Pinnacle's IDR at 'B+' and the Stable Outlook reflect Fitch's expectation that Pinnacle's leverage will decline to 6x or below over the next two to three years even if moderate revenue declines continue. Fitch's view is supported by Pinnacle's publicly stated goal of reducing debt, with the company targeting leverage of 4x or below. The deleveraging will be facilitated by Pinnacle's strong free cash flow (FCF) profile, which is supported by limited capital spending requirements and substantial net operating losses (NOLs) that will offset most if not all tax liability through 2017, the last year of Fitch's forecast.
With a 'B+' IDR there is less tolerance for company actions that could slow down the debt reduction given the difficult operating environment across most regional markets in which Pinnacle operates. Such actions might include Pinnacle executing leveraging acquisitions and initiating dividends or share repurchases. Pinnacle's operations will be challenged by the opening of the
Given the difficult operating backdrop, which Fitch expects will persist, Fitch sees Pinnacle's debt/EBITDA ratio remaining elevated above 6x until 2016. This compares to Fitch's prior expectation at the time of the
Fitch projects Pinnacle's debt/EBITDA at 6.4x for 2014 and 2015, 6.0x for 2016 and 5.7x for 2017. In Fitch's base case the debt reduction more than offsets the decline in EBITDA except in 2015, when the EBITDA decline is accentuated by the new competition in
Fitch's base case assumes that Pinnacle's revenues decline by 3% in the second quarter of 2014 on a same-store basis and then by 1% for the balance of the projection horizon (excluding
Fitch's base case assumes a 20% revenue decline in
Fitch's forecast assumes that Pinnacle applies all of its FCF to paying down term loan B2 and projects FCF at about
The FCF forecast for the outer years takes into account the following estimates:
--Property EBITDA of
--Corporate expense of
--Interest expense of
--Cash tax expense at about zero (
--Maintenance capex at
Fitch's assumption that all FCF will be used to pay down debt reflects the Pinnacle's consistently articulated goal of deleveraging, the lack of attractive growth opportunities, and the company's covenants. Pinnacle's credit agreement has a 50% excess cash flow sweep provision and limits restricted payments to
REGIONAL TRENDS TO REMAIN NEGATIVE
With no weather or calendar impediments, gaming revenues reported by the gaming regulators for May remained negative on year-over-year basis across regional markets on a same-store basis. Revenues were mostly down in the low single-digit range with the exception of the few more fragile markets such as
Fitch attributes the weakness in regional gaming to near-term and long-term headwinds. Near-term, the end of the federal unemployment benefits at year-end 2013 and the individual health insurance sign-ups related to the implementation of the Affordable Care Act (ACA) are having an impact. Annualized unemployment benefits are down
On the bright side, the EBITDA flow-through from the revenue declines has been relatively modest for most operators in 1Q'14 at around 40% as operators continue to cut costs. The low flow-through partially reflects the regional markets' high tax rates (
POTENTIAL FOR A REIT SPIN-OFF
Since Penn National Gaming (Penn) spun off its assets into a REIT (Gaming & Leisure Properties, Inc.; GLPI) in late 2013 there has been market speculation whether any of the other regional operators will consider a REIT spin-off. GLPI has been well-received by the equity markets with the company trading at about 14x-15x EV/EBITDA relative to the 7x-8x regional multiples. PNK has been routinely mentioned as the most likely candidate to do a spin-off given its better-than-industry-standard balance sheet, quality of assets, size and diversification. On
Fitch views the probability of Pinnacle executing a REIT spin-off as low in the near term and somewhere in the 50/50 range longer term (past 2017). Should Pinnacle pursue a REIT spin-off, Fitch may consider it a credit negative depending on how the transaction is financed. In the case of Penn, Fitch viewed the transaction negatively since the lease-adjusted leverage increased following the transaction.
Fitch believes Pinnacle may consider the spin-off once leverage improves, most of its bonds become callable, and its NOLs are close to being depleted. These conditions will not likely be met until 2017 at the earliest. Also, according to GLPI and Penn, a REIT spin-off is very complex and takes a long-time to execute. Nevertheless, should GLPI's multiples hold up, Fitch believes a spin-off would be tempting for Pinnacle, especially given the lackluster organic growth prospects.
The 'RR1' Recovery Rating (RR) on Pinnacle's senior secured credit facility results in a three-notch uplift from the IDR and takes into account Fitch's expectation of full recovery in an event of default. The 'RR3' on the senior unsecured notes (one-notch uplift from the IDR) reflects Fitch's expectations of better-than-average recovery for the senior notes in an event of default. The senior notes benefit from a quick paydown of Pinnacle's term loan and tight lien covenants in Pinnacle's senior notes indentures.
The 'RR6' on the subordinate notes reflects Fitch's expectation of minimal recovery in an event of a default and results in a two-notch negative differentiation from the IDR.
RATING SENSITIVITIES (Fitch forecasts in parentheses)
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
-- Fitch having less confidence that PNK's debt/EBITDA ratio will approach 6x by 2016 (FY16: 6.0x and FY17: 5.7x);
-- Same-store revenue declines significantly exceed Fitch's 1% per year projection for an extended period of time;
-- Discretionary FCF declining below
-- The company's adopts a more aggressive financial policy and starts to de-emphasize debt reduction;
-- PNK pursuing a REIT spin-off that would result in the rent adjusted leverage to increase.
Positive: No positive rating action is expected over the next 24 months given the company's high leverage. However, positive rating action may result from:
-- Debt/EBITDA declining below 5x;
-- Revenue growth stabilizing at or close to 0%;
-- Discretionary FCF exceeding
Additional information is available at 'www.fitchratings.com'.
--'Corporate Rating Methodology', (
--'Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers', (
--'U.S. Gaming Recovery Models - Fourth-Quarter 2013', (
--'2014 Outlook: U.S. Gaming (Deleveraging Potential)', (
--'Pinnacle Entertainment, Inc. -- Ameristar Acquisition Financing Considerations', (
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
U.S. Gaming Recovery Models ??? Fourth-Quarter 2013
2014 Outlook: U.S. Gaming (Deleveraging Potential)
Pinnacle Entertainment, Inc. -- Ameristar Acquisition Financing Considerations
Alex Bumazhny, CFA, +1-212-908-9179
Source: Fitch Ratings
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