Fitch Affirms Lion/Seneca France 2 at 'B'; Outlook Stable

<span id="midArticle_start"/>(The following statement was released by the rating agency)FRANKFURT/LONDON, May 28 (Fitch) Fitch Ratings has affirmedFrance-based optical retailer Lion/Seneca France 2 S.A.S.'s (Afflelou) Long-termIssuer Default Rating (IDR) at 'B'. The Outlook is Stable.Fitch has also affirmed 3AB Optique Developpement S.A.S.'sEUR365m senior secured notes due 2019 and super senior revolving creditfacility (RCF) ratings at 'BB-'/'RR2' and Lion/Seneca France 2 S.A.S.'s EUR75m seniornotes due 2019 rating at 'CCC+'/'RR6'.The rating reflects Afflelou's robust earnings and cash flowgeneration despite the challenging operating environment in France. The intrinsicstability of the issuer's business model is due to the favourable reimbursementpolicy in France, making optical products less price sensitive for consumers. Wesee little risk of weakening commercial quality as long as volume risks can beaddressed through the expansion of the store network activity and the priceelasticity of Afflelou's French operations, which account for 78% of totalnetwork sales, remains low with no material curtailments in the nationalreimbursement rates.KEY RATING DRIVERSConsolidation of Market PositionAfflelou continues to adapt its business strategy to thechallenging economic environment in France and leverage its position with suppliers.We expect overall negative organic network activity for FY15 supported byacquisitive growth outside France. Projected positive sales dynamics fromFY16 onwards remain subject to the accretive impact of the care networks andfurther add-on acquisitions. Operating margins are forecast at around 22%sustainably, driven by the supplier mix and the continuously high share of thedirectly owned stores.Contained Impact of DOSThe strong increase in the share of revenues generated bydirectly owned stores (DOS) has a credit dilutive impact as it weakens earnings andmargins. It also brings higher capital requirements and additional debt-likerental obligations to the otherwise asset light business model. We do not expect atangible reduction from DOS over the rating horizon, but project thatthey will have a relatively contained impact on the company's credit qualitygiven Afflelou's strategic preference to concentrate on the franchisee networkorganically and by acquisition.Neutral Effect from Regulatory ChangesWe expect the recently passed regulatory changes to have alargely neutral effect on Afflelou's commercial risk. The brand's strategicrepositioning towards national care networks should result in an expandedcustomer base and higher volumes, already observed in 2Q15. At the same time, anincreased market transparency is likely to intensify price competition amongoptical retailers and exert pressure on margins.Acquisitions Embedded in RatingBased on Afflelou's recently completed add-on acquisition andits M&A pipeline, the company is likely to continue looking for external expansionopportunities. We have therefore included an annual acquisition budget ofEUR10m for FY15 and FY16. Our projections are based on Afflelou's generatingpositive free cash flows with a margin sustainably above 8%, which wouldcomfortably accommodate add-on acquisitions from internal cash reserves withoutconstricting Afflelou's financial flexibility and liquidity position, and withoutweakening its overall credit profile.Robust Cash Flow GenerationCompared with other healthcare and retail peers, Afflelou hasgenerated relatively high funds from operations (FFO) margins and positivefree cash flow (FCF) margins, despite the challenging operating environment inFrance. We expect this trend to continue with a growing cushion to ourdowngrade sensitivity threshold of 8% for the FCF margin, driven byEBITDA-led FFO expansion and low capex nature of the franchisor business model.Leverage Commensurate with RatingOur peer analysis against other Fitch-rated healthcare creditssuggest that Afflelou's FFO adjusted leverage is comfortably positioned inthe 'B' rating category, demonstrating a similar de-leveraging trajectorytowards 6.0x in FY17. In contrast, traditional retailers of the same credit quality donot tolerate leverages above 6.0x, which is due to the intrinsically highervolatility of their earnings and cash flows. Superior Recoveries for Senior Secured CreditorsWe consider that the distressed valuation of the company wouldbe maximised in a going concern scenario as the business is fairly asset-light(franchisor business model). In addition, we believe that should Affleloudefault, this would not be the result of a broken business model but ratherdue to an adverse regulatory change (reimbursement policy) or unmanageablefinancial leverage.We have reduced the discount to 15% from 20% and applied it toJanuary 2015 LTM EBITDA of EUR70m leading to a post-restructuring EBITDA ofEUR.60m. This remains the appropriate sustained post-restructuring earningsestimate, in our view, given Afflelou's sustained post-restructuring cashoutlays. We maintained the distressed EV/EBITDA multiple at 5.5x in line with 'B'category peers in the sector.Our analysis results in superior recovery prospects for both thesuper senior RCF (capped at 90% due to the French jurisdiction) and seniorsecured notes at 'RR2' and very limited recovery prospects for the senior notesat 'RR6'. We note however that with the estimated recovery rate of RR2/72% thesenior secured notes are positioned at the very low end of the RR2 band(71-90%), and any further sustained deterioration in EBITDA may result in anegative outlook for the IDR, leading to a senior secured notes downgrade.Fitch notes that the convertible bond held at the level ofLion/Seneca Lux 2 is treated as 100% equity and is excluded from the debtcalculation.KEY ASSUMPTIONSFitch's key assumptions within the rating case for Afflelouinclude:- Low single digit organic sales growth rates.- Acquisitive annual sales expansion of EUR7m-EUR14m in FY15-17.- EBITDA margin sustainably at 22.3%.- Capex at EUR10m p.a.- Annual acquisition budget of EUR10m in FY15 and FY16, fundedfrom internal cash reserves.RATING SENSITIVITIESPositive: Future developments that could lead to positive ratingaction include:- Stable to improving EBITDA margin driven by stable toexpanding network activity and no negative impact from regulatory changes- FFO gross adjusted leverage below 5x- FFO fixed charge cover improving towards 2.5x.Negative: Future developments that could lead to negative ratingaction include:- Deterioration of EBITDA and FCF margins as a result ofcontinued weak network activity, impact of regulatory changes, adverse supplier mixchanges or further material increase of the DOS segment- FFO gross adjusted leverage above 7x or no evidence ofdeleveraging, for example because of operating underperformance or on-goingacquisition activity- Any sign that internet is becoming a serious threat, reflectedin negative like-for-like sales growth on a sustained basis- Unsuccessful integration of new material acquisition/s- FFO fixed charge cover of 1.8x or below..These ratios are based on Fitch-calculated metrics.LIQUIDITYSufficient LiquidityAfflelou is projected to remain cash generative with annual FCFgeneration of around EUR30m-EUR35m, provided no further substantial netadditions of DOS is taking place as in FY14. These levels of organic liquidity canaccommodate small acquisitions of up to EUR10m p.a. without compromising itsfinancial flexibility. Given Afflelou's position of a payment intermediarybetween suppliers and stores and by using Dailly assignments, asimplified form of receivables assignments, its working capital exposure isrelatively short, mostly on an intra-month basis. In addition, the company canresort to the currently undrawn RCF of EUR30m due November 2018.Business Accommodating Debt PackageFollowing the issuance of the notes in 2014, Afflelou faces noshort-term refinancing risk. Its back-ended, although concentrated debtstructure with both notes maturing in April 2019, bears no interest rate risk andallows for a reasonable operational flexibility, given the presence of onlyone springing covenant under the RCF with min EBITDA level. However, due toAfflelou's highly leveraged capital structure, its financial flexibility islimited.FULL LIST OF RATING ACTIONS3AB Optique Developpement S.A.S.--Super senior RCF 'BB-'/RR2/90%--Senior secured notes 'BB-'/RR2/72%Lion/Seneca France 2 S.A.S--Senior notes 'CCC+'/RR6/0%Contact: Primary AnalystElena StockDirector+49 69 76 80 76 135Fitch Deutschland GmbHNeue Mainzer Strasse 46-50D-60311 Frankfurt am MainSecondary AnalystPatrick DurcanAnalyst+44 20 3530 1298Committee ChairpersonDeborah OgawaSenior Director+44 20 3530 1743Media Relations: Peter Fitzpatrick, London, Tel: +44 20 35301103, Email: peter.fitzpatrick@fitchratings.com.Additional information is available on http://ift.tt/1DUzHLW Criteria Corporate Rating Methodology - Including Short-Term Ratings andParent and Subsidiary Linkage (pub. 28 May 2014)hereRecovery Ratings and Notching Criteria for Non-FinancialCorporate Issuers (pub. 18 Nov 2014)hereAdditional Disclosures Solicitation Status here<a href="http://ift.tt/1F8wk51 =2&detail=31">Endorsement Policy ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS ANDDISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THISLINK: here. IN ADDITION,RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLEON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS,CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'SCODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATEFIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLEFROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHERPERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES.DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN ANEU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUERON THE FITCH WEBSITE.

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