OREANDA-NEWS. Fitch Ratings has affirmed Punch Taverns Finance plc's (Punch A) super senior hedge notes (SSHN), class A1(F), A2(F), A1(V), A2(V) and class M3 notes, as follows:

GBP34.6m floating-rate SSHN due 2021: affirmed at 'BB+'; Outlook Stable

GBP189.5m Class A1(F) fixed-rate notes due 2026: affirmed at 'BB'; Outlook Stable

GBP126.7m Class A2(F) fixed-rate notes due 2025: affirmed at 'BB'; Outlook Stable

GBP67.5m Class A1(V) fixed-rate notes due 2026: affirmed at 'BB'; Outlook Stable

GBP45.8m Class A2(V) fixed-rate notes due 2025: affirmed at 'BB'; Outlook Stable

GBP300m Class M3 floating-rate notes due 2027: affirmed at 'B-'; Outlook Stable

During the 12 months to March 2016 Punch continued its strategy of selling off non-core pubs in order to improve the overall quality of the remaining estate and pay down debt. Key performance indicators have fallen as a result, but performance on a per pub basis is more stable, and investment has continued, which should support future performance improvement. FY2015 like-for-like net income growth of 0.3% at the group level also highlights ongoing stabilisation.

The Stable Outlook is underpinned by the ongoing deleveraging and improved projected debt service coverage ratio (DSCR) metrics versus the previous year. It is also supported by peer comparison, which indicates that the SSHN, class A and class M notes are well aligned in terms of leverage and projected DSCRs.

TRANSACTION PERFORMANCE

The ongoing disposals mean that revenues and EBITDA continued to decline on an absolute basis by 3% and 9%, respectively, after adjusting for the 53 week previous year. This resulted in trailing 12 months EBITDA to March 2016 of GBP110m. However, performance was slightly stronger on a per pub basis, with revenues growing by 4% and EBITDA declining by only 2%. The relatively weak EBITDA performance was driven by a substantial increase in opex over the year due to the development of the Retail Agreement team, which we expect to be an initial one-off setup expense. EBITDA margins therefore also deteriorated by 3ppt to 44%.

The ongoing disposals facilitated further investment and debt prepayments. Punch spent GBP31m on the Punch A estate over the year, which equates to around GBP15,000 per pub - well in excess of the minimum required spend of GBP8,000 per pub. The SSHN balance reduced to GBP35m from GBP109m, representing a 68% reduction in principal outstanding over the year. Ongoing scheduled amortisation of the class A(F) notes also contributed to total leverage through the class A notes reducing by 9% to 4.2x. Class M leverage also improved slightly to 7.0x and reported metrics were relatively stable over the year.

The updated projected synthetic DSCR metrics improved to 40.5x, 2.5x and 1.0x from 7.4x, 2.2x and 0.9x through the SSHN, class A and class M notes as a result of the ongoing deleveraging. In comparison with peers such as Unique Pub Finance Company plc, Punch A is reasonably well aligned in terms of projected coverage and leverage when adjusting for differences in the financial structure such as Punch A's exposure to refinancing risk.

KEY RATING DRIVERS

Industry Profile - Midrange

The pub sector in the UK has a long history, but trading performance for some assets has shown significant weakness in the past. The sector has been in a structural decline for the past three decades due to demographic shifts, greater health awareness and the growing presence of competing offerings. Exposure to discretionary spending is high and revenues are therefore inherently linked to the broader economic cycle. We view competition as high including off-trade alternatives, and barriers to entry are low, despite increasingly demanding regulations. Despite the on-going contraction, Fitch views the eating - and drinking-out market as sustainable in the long term, supported by the strong pub culture in the UK.

Sub-key rating drivers (KRD) Operating environment: Weaker; Barriers to entry: Midrange; Sustainability: Midrange

Company Profile - Midrange

EBITDA per pub has stabilised over the past five years, mainly as a result of extensive disposals of weakly performing non-core pubs and increased investments in the core estate following years of capex underspend. The leased/tenanted business model makes it more challenging for the Punch group to adapt to the growing eating-out market in the UK, as it has reduced control over publicans' strategy and less cash to spend on capex due to performance declines. Furthermore, limited visibility with respect to the tenants' profitability means that the sustainability of the cash flows generated by tenanted pubs is more difficult to estimate. However, we expect the continued disposals of non-core pubs, combined with increased capex invested in the core estate, to result in an overall improved quality of the estate in the foreseeable future.

Sub-KRDs: Financial performance: Weaker; Company operations: Midrange; Transparency: Weaker; Dependence on operator: Midrange; Asset quality: Weaker

Debt Structure - Midrange (SSHN, A1(F), A2(F), A1(V), A2(V)) and Weaker (M3)

The Midrange assessment of the debt structure with respect to the senior debt is a reflection of the partial repayment from cash sweep (SSHN, A1(V), A2(V)) and scheduled amortisation (A1(F) and A2(F)), which contributes to some de-leveraging. This somewhat mitigates risks around the ability to refinance debt (or the reliance on core pub disposal proceeds, which is another way to fund debt repayment) at or prior to legal maturity. However, we do not expect the junior ranking class M3 notes to benefit from any amortisation prior to maturity.

There is some floating rate exposure due to the unhedged floating-rate SSHN. However, ongoing prepayment means only 4% of total debt outstanding is floating rate so we view the risk as negligible. The security package is standard for UK whole business securitisation (WBS) transactions. Operational and financial covenants are satisfactory, although we note the exclusion of the bullet repayments for the purpose of calculating the free cash flow (FCF) debt service coverage ratio (DSCR) as well as the possibility of preventing a covenant breach through the availability of disposal proceeds, which are part of the FCF definition.

We view the inclusion of a leverage covenant as mitigating this relative weakness. In terms of cash lockup provisions, only a group service payment of up to 2% of EBITDA can be up-streamed (i. e. paid to outside the securitised group) if a) no borrower event of default has occurred and b) the net senior leverage is below the closing level, which is a credit positive. The liquidity facility is structured to cover 18 months of peak debt service. However, this represents effectively only interest payments on the rated notes and scheduled amortisation with regard to the class A1(F) and A2(F) notes (excluding final bullets).

Typically UK WBS allow debt tranches ranking below the most senior notes to defer interest and scheduled principal payments if available cash is insufficient to cover debt service. However, the ratings of the A(F) notes and the A(V) are aligned, given that a failure to pay interest (or final principal) on the more junior ranking A(V) notes would result in an issuer event of default due to the A(V) notes' non-deferability.

The most senior ranking SSHN are rated one notch above the non-deferrable subordinate ranking class A(F) and A(V) notes due to their earlier maturity in 2021 and lower refinance risk compared with the class A notes (as the SSHN mature in 2021 they are not exposed to a potential inability of the class A notes to refinance in 2025 and 2026). A payment default under the class A notes prior to the SSHN's full repayment would still trigger an issuer event of default, affecting the then outstanding SSHN. This limits the uplift to one notch.

Sub-KRDs: Debt profile: Midrange (SSHN, classes A1(F), A2(F), A1(V), A2(V)) and Weaker (class M3); Security package: Stronger (SSHN) and Midrange (classes A1(F), A2(F), A1(V), A2(V), M3); Structural features: Midrange

RATING SENSITIVITIES

SSHN, class A, class M - Negative: Any significant deterioration in performance leading to a worsening of projected DSCR levels and deleveraging profile, could impact the ratings. Specifically, five-year leverage expectations above 3.5x and 6.5x through the class A and class M notes, respectively, could trigger negative rating action. Furthermore, the anticipation of a failure to refinance maturing debt tranches would lead to negative rating action.

SSHN, class A, class M - Positive: The notes are unlikely to be upgraded in the foreseeable future.

SUMMARY OF CREDIT

The transaction is a securitisation of tenanted pubs in the UK. As of March 2016 the transaction consisted of 1,931 pubs (1,670 pubs in the core estate and 261 in the non-core estate), versus 2,108 (1,714 core and 394 non-core) pubs, a reduction of 8%.