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Rating Action:

MOODY'S RATES PETCO'S BANK DEBT Ba3, UPGRADES SUB NOTES TO B2

21 Oct 2002
MOODY'S RATES PETCO'S BANK DEBT Ba3, UPGRADES SUB NOTES TO B2

Approximately $438 Million of Debt Affected.

New York, October 21, 2002 -- Moody's Investors Service upgraded the debt ratings of Petco Animal Supplies, Inc., and assigned a rating of Ba3 to Petco's new secured term loan maturing 2008. The rating outlook has been changed to stable from positive following the ratings upgrades. The following ratings were affected by this action:

Senior implied rating to Ba3 from B1;

Secured $75 million revolving credit facility due 2006 and $193.5 million term loan maturing 2008 to Ba3 from B1;

$170 million 10.75% senior subordinated notes due 2011 to B2 from B3;

Issuer rating to B1 from B2.

The ratings reflect the expectation that Petco will retain its prudent growth strategies and continue to improve operating performance, which would enable the company to finance new stores and reduce leverage from internally generated cash flow. The ratings also recognize Petco's good market position and the tested stability of this retail model; recent reductions in debt from operating cash flow and cash received from its IPO; the expectation of higher returns on assets; and amendments to its bank facilities in the form of reduced interest rates which benefit the company.

Petco's ratings are constrained by high effective leverage and relatively low fixed charge coverage levels for its rating category; thin asset coverage for all debt; a large and diversified group of direct and indirect competitors which could affect Petco's market position or profitability; and the potential for store productivity to fall based on growth of competitors or of Petco's own stores.

The $193.5 million Term Loan C repaid previously existing facilities whose ratings have been withdrawn. The Ba3 ratings on the secured facilities reflects their seniority in Petco's rating structure as a result of their collateral package, which consists of essentially all of the company's assets. The ratings also reflect somewhat thin asset coverage based on the value and nature of the security. Petco's current assets in August 2002, which included $43 million of cash, were about only $20 million higher than outstandings under the term loan facility. Petco's other assets consist principally of fixtures and other store assets whose value could deteriorate in a liquidation.

The rating outlook is stable. Petco's ratings anticipate that the company will continue to improve profitability and generate sufficient positive cash flow during the medium term to finance its growth objectives. Systems improvements have enabled Petco to improve inventory turns, reducing the need for additional working capital investment as the company has grown. Store productivity has also remained satisfactory despite the fact that most new openings have been in existing markets, as improved operating leverage has more than offset any cannibalization. The ratings could respond positively to better than expected operating improvements or accelerated debt reduction. Ratings could respond negatively to re-leveraging events or acquisition activities, or to changes in Petco's operating environment which could negatively affect its prospects.

Petco's debt protection measures are weak relative to other specialty issuers at this rating level, but Moody's believes the business model has demonstrated good stability in terms of customer traffic and sales patterns. Pet superstores have shown good top line performance during a period when other concepts have given market share to discounters and other general retailers. Top line performance in the post-9/11 period, when most other retail concepts suffered significant comparable store sales declines, is also indicative of the stability of sales and customer traffic. Moody's also believes that Petco's trend of improved operating profits is sustainable, and expects the company to continue to improve the productivity of its operations. Petco's revenue continues to shift to a more profitable mix due to the increase in high-margin services and supplies. Sale volumes of consumables and use of the loyalty program continue to indicate that the company is retaining repeat traffic for the product categories most commonly carried by supermarkets and discount stores.

Moody's expects Petco's EBITDAR to fixed costs to be in excess of 1.8 times for the year ending January 2003. EBITDAR less capex to fixed costs is expected to be about 1.4 times, indicating the ability to finance growth from operating cash flow and rely on the revolver primarily for seasonal working capital needs. Both of these measures are expected to improve in the future. Debt to EBITDA, which was 3.3 times for the prior fiscal year, is expected to improve to 2.3 times as a result of higher profitability and lower debt balances. Effective lease adjusted debt is also expected to come down substantially, but will continue to be somewhat high for this rating category.

Petco Animal Supplies, Inc., headquartered in San Diego, California, is one of the two major operators of pet superstores in the U.S. Revenues were $1.3 billion in the year ended February 2002.

New York
Andris G. Kalnins
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Marie Menendez
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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