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Fitch Revises R.R. Donnelley’s Outlook from Stable to Negative

August 8, 2012
NEW YORK—August 8, 2012—Fitch Ratings has affirmed R.R. Donnelley & Sons’ (RRD) Issuer Default Rating (IDR) at BB+ and revised the Rating Outlook to “Negative” from “Stable.” In a previous notice, Fitch had stated its concern that revenue declines in the low to mid-single digits could pressure cash flows and slow down absolute debt reduction and thereby lead to an outlook revision or rating change.

RRD revised guidance for 2012 revenues to $10.4-$10.5 billion, which includes $160 million related to the unfavorable impact of foreign exchange and pass through paper revenues. The company’s previous guidance for revenues was to be flat to slightly up from 2011 revenues of $10.6 billion, excluding the impact of foreign exchange and pass through papers.

While the guidance change in absolute terms is de minimis, Fitch is concerned organic revenue growth will continue to be challenged and given the limited headroom within the ratings, any unexpected weakness in the economy or in RRD’s operating performance could reduce the level of cash generated, slowing the pace of absolute debt reduction.

Fitch notes that RRD affirmed its guidance of approximately $300 million in free cash flow (after dividends). Fitch believes this is achievable. While Fitch now expects revenues to be down in the low single digits, Fitch expects EBITDA to remain unchanged relative to 2011 EBITDA of $1.2 billion.

As of June 30, 2012, RRD had total debt of $3.8 billion. Fitch calculates unadjusted gross leverage (without adding back restructuring charges) at 3.2 times (x). The ratings reflect the company’s intention to reduce 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 RRD’s stated leverage target of 2.5x - 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 free cash flow (FCF) going forward in order to maintain 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.

Rating Drivers:


• Ratings may be stabilized if the company executes on its intention to reduce absolute levels of debt and is able to demonstrate organic revenue growth.

• Sustained revenue declines and/or heightened concerns regarding secular challenges would likely result in a one notch rating downgrade.

Liquidity:

Fitch calculates RRD’s FCF (after dividends) for the last 12 months ended June 30, 2012 at $381 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 $205 million to its various retirement funds, including its pension, in 2012. The 2012 contribution is reflected in Fitch’s FCF expectations. The updated contributions reflect the passing of the Surface Transportation Extension Act of 2012, which provided pension funding relief.

As of June 30, 2012, liquidity was supported by $369 million in cash ($338 million located outside of the U.S.) and $1 billion available under its $1.75 billion revolver that matures in December 2013.

As of June 30, 2012, there is approximately $325 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 percent notes due in April 2014, $300 million 5.5 percent notes due in May 2015 and its $347 million 8.6 percent notes due in August 2016.

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 $140 billion. 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% 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.

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+.

Source: Fitch.
 

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