-- U.S. marketing services company Valassis Communications Inc.’s operating trends have weakened, and face longer-term secular challenges associated with direct mail and newspapers.
-- We are revising our rating outlook on the company to stable from positive; our ratings on the company, including the ‘BB-’ corporate credit rating, are affirmed.
-- The stable rating outlook reflects our expectation that while near-term operating trends could remain difficult, debt leverage will likely continue in the low-2x area.
On Feb. 29, 2012, Standard & Poor’s Ratings Services revised its rating outlook on Livonia, Mich.-based Valassis Communications Inc. to stable from positive. Our ratings on the company, including the ‘BB-’ corporate credit rating, were affirmed.
The outlook change reflects our view that near-term operating trends at Valassis will remain weak. Our ‘BB-’ rating incorporates the expectation that leverage will remain in the low 2.0x area over the next 12 months. We assess Valassis’ business risk profile as “weak,” according to our criteria, acknowledging a high level of volatility in shared mail profitability, competitive pressures in the freestanding insert (FSI) and shared mail markets, a low EBITDA margin, and a narrow business focus.
We view the company’s financial risk profile as “significant,” based on historical volatility in leverage and discretionary cash flow generation. These negative factors are only partly offset by management’s solid track record of debt repayment and adequate liquidity.
The shared mail division generated roughly 60% of revenue in 2011, and is subject to uncertainty regarding the long-term prospects for the direct mail business. The industry faces increasing pressures from various online advertising channels. Online channels account for less than 10% of Valassis’ revenues.
We believe the long-term competitive dynamics of the direct mail industry will remain difficult. FSIs (about 10% of revenue) are a mature business, competing increasingly with online advertising, and are subject to unfavorable trends in the newspaper business. Despite being essentially a duopoly, the FSI sector is subject to keen ad pricing competition. Previously Valassis’ overall business had been somewhat recession-resistant; however recent operating trends indicate the current weakness and budgetary pressures on consumer packaged goods companies could persist.
Unexpectedly high coupon redemption rates in the first half of 2011 exhausted consumer packaged goods clients’ marketing budgets, leaving a minimal portion of the marketing budget available for Valassis’ marketing communications. We expect budgets for 2012 to be affected by broad economic weakness and digital competition. Our 2012 base-case assumptions include flat- to low-single-digit percentage revenue and EBITDA growth, respectively.
We expect the EBITDA margin to remain flat or experience a slight improvement from modest cost-reductions. Fourth-fiscal-quarter operating performance was broadly in line with our expectations. This reflected a 5.7% revenue decline, offset by cost efficiencies resulting in an EBITDA increase of 12%. Lease-adjusted debt to EBITDA fell to 2.2x for the 12 months ended Dec. 31, 2011, from 2.5x for the same period last year.
Leverage is lower than the indicative ratio for what we consider significant financial risk, which we view as appropriate based on the company’s business risk. EBITDA coverage of cash interest expanded to 7.2x for the 12 months ended Dec. 31, 2011, up from 4.5x for the same period last year, primarily as a result of debt reduction.
Without a leveraging transaction, we believe operating conditions will result in leverage in the low 2.0x area and interest coverage above 7x during 2012. Although credit measures are good for the current rating, further rating upside potential depends on the company’s management of its balance sheet and regaining stability across all divisions.
Liquidity Valassis has adequate sources of liquidity to more than cover its needs over the next 12 to 18 months, even in the event of moderate unforeseen EBITDA declines.
Expectations and assumptions that support our liquidity assessment include:
-- We expect the company’s sources of liquidity (including cash and availability under the revolving credit facility) over the next 12 to 18 months to exceed uses by 1.2x or more.
-- We expect net sources of liquidity would be positive even with a 15% to 20% or more drop in EBITDA over the next 12 months. Debt maturities over the next 12 months are minimal.
-- We estimate the company would continue to maintain an adequate cushion of compliance with its financial covenants even with a 15%-20% decrease in EBITDA.
-- The company has a generally satisfactory standing in credit markets, in our view. Liquidity is provided by $102 million of cash on hand and $40.1 million of availability as of Dec. 31, 2011 (net of $8.9 million of outstanding letters of credit) on Valassis’ recent $100 million revolving line of credit due 2016.
Cash on hand reflects the $301.4 million received in the settlement with News America, net of taxes and related payments. We expect discretionary cash flow of between $125 million and $150 million in 2012. Valassis has limited maturities over the near term. In our 2012 base case, based on management’s public statements, we assume that the company will likely use nearly one-half of expected discretionary cash flow for share repurchases or acquisitions. The company has used $215 million for repurchases in 2011. Outlook Our stable rating outlook on Valassis reflects the company’s adequate liquidity position and our expectation that operating trends will continue to improve modestly in 2012. We believe the company likely will maintain leverage in the low-2x area in 2012. Upgrade potential still exists but is less compelling at this time because of weak operating trends in the last several quarters and ongoing pressure from digital alternatives
. Rating upside potential relies on the company’s balance sheet management and stabilization in operating trends. A downgrade could occur in the event of a reversal in operating trends, along with a more aggressive financial policy, resulting in further contraction of the EBITDA margin, a significant increase in leverage, and a reduction of liquidity. Related Criteria And Research -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008