Fitch Ratings has assigned a 'BBB-' rating to R.R. Donnelley & Sons Company's (RRD) proposed senior secured bank credit facility of up to $1.25 billion. Fitch has also downgraded RRD's Issuer Default Rating (IDR) and senior unsecured notes and debentures to 'BB' from 'BB+'. The Rating Outlook remains Negative.
The new secured facility will replace the $1.75 billion unsecured credit facility, which was due to expire in December 2013. While the total facility has been reduced, Fitch notes that availability under the $1.75 billion had been constrained by the bank agreement leverage covenant. Fitch believes that the $1.25 billion secured facility will provide sufficient liquidity to support operations and investments. Terms of the proposed credit facility have not been disclosed.
The notching on the secured credit facility reflects the benefit from its security package and resulting priority in the capital structure.
The ratings and Negative Outlook reflect the secular challenges facing RRD. In Fitch's view, more than 50% of RRD's revenues face some degree of secular headwinds (catalogs, magazines, books, directories, variable, commercial and financial print). Fitch does not believe certain sub-segments will exhibit positive organic growth going forward.
Fitch believes RRD carries a high level of debt given the secular challenges facing the company. As of June 30, 2012, RRD had total debt of $3.8 billion. As with other issuers and segments with uncertain business prospects, Fitch will weight secular issues, organic growth and absolute levels of debt reduction more prominently than backward looking leverage metrics. Based on current expectations, Fitch believes that the company has the financial flexibility to reduce debt levels; however, Fitch is concerned that an acceleration in secular driven revenues declines may impair that ability.
Fitch believes that the company's financial and management strategies are appropriate and prudent for the current ratings. Management has publicly stated its intentions to reduce absolute levels of debt. Fitch calculates unadjusted gross leverage (without adding back restructuring charges) at 3.2 times (x). Debt reduction will need to be a primary use of free cash flow (FCF) going forward in order to maintain current ratings. There is no tolerance in the ratings for material share buy backs and/or increases in the current dividend level.
RRD expects approximately $300 million in FCF (after dividends). Fitch believes this is achievable. Fitch expects 2012 full year revenues to be down in the low single digits, and EBITDA to remain unchanged relative to 2011 EBITDA of $1.2 billion. Fitch's base case model assumes that pressures in the Books and Directories segment accelerate and revenues in this business line declines in the mid-teens starting in 2013.
The ratings also reflect RRD's scale and diverse product offering as the largest commercial printer in the U.S. and worldwide. The U.S. commercial printing market size is approximately $140 billion. RRD is one of few well-capitalized competitors in this highly fragmented and sizeable industry. The significant addressable market share that RRD could capture from rivals may provide some offset to secular pressures.
Fitch calculates RRD's FCF (after dividends) for the last 12 months ended June 30, 2012 at $381 million. RRD's pension was $1 billion underfunded at the end of 2011. The company intends to contribute $205 million to its various retirement funds, including its pension, in 2012. The 2012 contribution is reflected in Fitch's FCF expectations. The contributions reflect the passing of the Moving Ahead for Progress in the 21st Century Act, which provided pension funding relief.
As of June 30, 2012, the company held $369 million in cash ($338 million located outside of the U.S.) and had $325 million drawn under its credit facility. RRD's next bond maturity is its $258 million 4.95% notes due in April 2014, $300 million 5.5% notes due in May 2015 and its $350 million 8.6% notes due in August 2016.