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Fitch Affirms R.R. Donnelley’s BB+ Default Rating, Classifies Outlook as Stable

May 14, 2012
NEW YORK—May 14, 2012—Fitch Ratings has affirmed R.R. Donnelley & Sons’ “BB+” issuer default rating (IDR). The rating outlook is stable. The ratings reflect the company’s intention to reduce its absolute levels of debt.

Given RRD’s cash flow generation, Fitch believes that the company can meet its pension funding requirements and reduce debt balances in order to get closer to the lower end of the company’s stated leverage target of 2.5-3.0x, which Fitch believes is appropriate for the ratings at this time.

As with ratings on any business facing secular challenges, Fitch may continue to tighten the targeted leverage metric for a given rating category as business risk increases.

Fitch believes that debt reduction will need to be a primary use of RRD’s free cash flow (FCF) going forward in order to maintain its current ratings. Given the secular challenges facing the company, deleveraging will primarily be driven through debt level reductions. There is no tolerance in the ratings for material share buy backs and/or increases in the current dividend level.

There is limited headroom within the ratings for the company to under perform Fitch expectations. The company has guided to flat to slight revenue growth and approximately $300 million in FCF (after dividends). Fitch believes this is achievable.

Revenue declines in the low to mid single digits over the next two quarters could result in a Negative Outlook. Fitch believes that continued revenue declines in the low to mid single digits would pressure cash flows and slow down absolute debt reduction.

The ratings also reflect:

• RRD’s scale and diverse product offering as the largest commercial printer in the United States and worldwide. The U.S. commercial printing market size is approximately $150 billion, and RRD has less than a 5 percent market share. RRD is one of few well-capitalized competitors in this highly fragmented and sizable industry. The significant addressable market share that RRD could capture from rivals may provide some offset to secular pressures.

• In Fitch’s view, more than 50 precent of RRD’s revenues face some degree of secular headwinds (catalogs, magazines, books, directories, variable, commercial and financial print). Certain sub-segments may not recover or exhibit positive growth characteristics going forward.

Fitch believes that continued pricing and volume pressure will challenge RRD’s ability to drive GDP-level organic revenue growth. 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.

Rating Drivers:


• Given the secular challenges facing the company’s business, Fitch does not expect any positive rating momentum in the near term.

• Increased share buyback activity or revenue declines in the low to mid single digits, whether due to secular/cyclical issues, would pressure the ratings.

Liquidity:

Fitch calculates RRD's FCF (after dividends) for the last 12 months ended March 31, 2012 at $455 million. Fitch expects FCF to be approximately $300 million in 2012. RRD's pension was $1 billion underfunded at the end of 2011. The company intends to contribute $215 million to its pension funds in 2012. The 2012 contribution is reflected in Fitch’s FCF expectations.

As of March 31, 2012, liquidity was supported by $415 million in cash ($370 million located outside of the U.S.) and $1.2 billion available under its $1.75 billion revolver that matures in December 2013.

As of March 31, 2012, there is approximately $327 million in revolver debt balance outstanding, reflecting seasonal working capital balances and borrowing used to fund the January 2012 $160 million maturity. After the revolver balance has been repaid, Fitch expects the company to continue to reduce debt through repurchases of notes in the open market or via tender offers.

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 $347 million 8.6% notes due in August 2016.

Leverage:

As of March 31, 2012, the company had total debt of $3.8 billion.

The company calculates leverage at 3.0x as of March 31, 2012, excluding restructuring cost. Given the secular issues facing RRD, Fitch will no longer adjust EBITDA for restructuring charges, resulting in an unadjusted gross leverage ratio of 3.2x. Fitch believes restructuring charges will be an ongoing expense. While current leverage is high for the rating, Fitch expects leverage to be below 3.0x before year end.

Covenants:

Fitch notes that liens are not permitted under the existing bonds, unless a pari passu lien is granted to the notes. There is also a general lien basket that limits liens (and sale-leaseback transactions) to 15% of net tangible assets (there is a 10% limit for the notes maturing in 2021, 2029, and 2031).

While the company's credit facility contains a 4.0x maximum leverage covenant, current bondholders do not benefit from any material unsecured debt or unsecured subsidiary guarantee restrictive covenants. Fitch notes that in the event that the credit facility became guaranteed by the operating subsidiaries of RRD (noting that the revolver does not expire until Dec. 17, 2013), Fitch would expect to notch down the unsecured notes, reflecting this subordination.

Fitch has affirmed R.R. Donnelley's ratings as follows:
  • IDR at BB+;
  • Senior unsecured revolving credit facility at BB+;
  • Senior unsecured notes and debentures at BB+.

Fitch has also withdrawn the following ratings:
  • Short-term IDR, B;
  • Commercial paper, B.

Source: Fitch.
 

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