S&P Global ratings has assigned its point-in-time ‘B’ rating to California Pizza Kitchen Inc.’s (CPK) $107 million of debtor-in-possession (DIP) debt provided to the U.S.-based restaurant operator. Its ‘D’ rating on CPK is unchanged.
S&P’s ‘B’ issue rating on CPK’s DIP financing facilities reflects its view of the credit risk borne by the DIP lenders.
These risks include:
— The company’s ability to meet its financial commitments during bankruptcy through S&P’s debtor credit profile (DCP) assessment.
— Prospects for full repayment through reorganization and emergence from Chapter 11 via S&P’s capacity for repayment at emergence (CRE) assessment.
— Potential for full repayment in a liquidation scenario via S&P’s additional protection in a liquidation scenario (APLS) assessment.
S&P’s DCP reflects its view of CPK’s vulnerable business risk profile and highly leveraged financial risk profile.
“Our DCP includes our consideration of applicable rating modifiers, including our projected liquidity of CPK during bankruptcy. The issue rating on the company’s DIP also considers the potential recovery prospects on the DIP loans, which are reflected in our CRE and APLS assessments,” S&P said.
S&P’s CRE assessment of favorable coverage of the DIP debt in an emergence scenario indicates coverage of 150%-250%.
“Our CRE assessment contemplates a reorganization and addresses whether the company, in our view, would likely be able to attract sufficient third-party financing at the time of emergence to repay the DIP debt in full. Our CRE assessment of favorable coverage of the DIP debt provides a one-notch uplift over the DCP assessment, resulting in a ‘B’ issue-level rating. S&P assesses repayment prospects for purposes of the CRE assessment on the basis that the company must repay all of the DIP facilities in full in cash at emergence, consistent with super-priority status under the U.S. Bankruptcy Code,” the rating agency said.
S&P’s APLS assessment indicates less than 100% total value coverage and does not affect DIP ratings.
S&P’s DIP methodology also contemplates the ability to fully repay DIP debt, even in a scenario where the debtor cannot reorganize under bankruptcy protection. S&P’s APLS assessment indicates insufficient coverage (estimated at 30%-50% coverage) of the DIP term loan in a liquidation scenario, and therefore, the rating agency does not provide an additional notch for the APLS modifier.
S&P attributes CPK’s voluntary bankruptcy filing to the coronavirus pandemic, various ongoing business challenges, and weakened competitive position.
CPK’s bankruptcy filing and S&P’s business risk assessment reflect various ongoing business challenges, including:
— S&P’s expectation for economic weakness through the bankruptcy period, along with business and operational disruptions because of the COVID-19 pandemic;
— Erosion in revenue and profitability because of increased competition in the restaurant industry amid shifts in consumer spending habits;
— Changing consumer behavior including the increased adoption of third-party delivery services and increased online purchasing, all resulting in fewer dine-in customers and increased industry competition;
— Investment market and operational disruptions that prevented the company from adequately addressing its capital structure including financial maintenance covenants; and
— These factors result in significant recent declines in sales, profitability, and cash flow that resulted in a prepetition capital structure that was unsustainable.
S&P sees many of these trends as secular and believe customer traffic will remain challenged, especially for dine-in services especially in regions experiencing significant effects of the pandemic, making it difficult for CPK to substantially reverse declines in sales and EBITDA margins over the short term. S&P believes the company’s competitive position has materially weakened in recent years, largely because of these industry trends and intensifying competition. S&P holds this view despite believing that CPK’s bankruptcy restructuring initiatives may result in modest operating performance improvements as the result of:
— Plans to close a meaningful number of underperforming stores;
— Lease and rent negotiation with landlords that result in concessions and cost reductions; and
— Continued efforts to enhance the company’s off-premise sales along with other changes to the menu offerings and the business model.
From a financial risk perspective, S&P’s DCP reflects a substantially reduced debt burden relative to EBITDA generation in the bankruptcy period.
This is due to the automatic stay on prepetition debt (about $403 million at the time of filing) and the relatively modest amount of funded DIP debt (about $107 million). Still, the requirement to pay adequate protection to the prepetition term lenders diminishes the cash flow benefit during bankruptcy. S&P is also mindful about the level of DIP debt relative to the company’s expected EBITDA over the next 12 months, given the expected global recession from the COVID-19 pandemic and its effects on overall expected industry trends.