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October 1, 2012

Analysts Weigh In On BJ's Credit Downgrade

One year after BJ's Wholesale Club was acquired and became a private company, a credit downgrade from Moody's Investors Service called attention to the company's fiscal health. But how much the downgrade says about the company's future success is arguable.

The Westborough-based company, founded in 1984, operates more than 190 stores in 15 states on the Eastern seaboard. According to BJ's last 10-K report as a public company, which was filed in March 2011, the company steadily added stores through 2011, resulting in an increase in net sales.

Then, Leonard Green & Partners LP, a California-based private equity firm, purchased BJ's for $2.8 billion in September 2011.

When Moody's downgraded the company's debt from a B1 to a B2, it did so because of what senior analyst Charlie O'Shea labeled a "highly aggressive shift in financial policy."

O'Shea was referring to the company's plans to raise $690 million in new debt to pay back investors who financed the acquisition.

Alex Tarantino, a financial analyst with PrivCo, a New York-based firm that provides financial analysis for private companies, said Leonard Green is simply recapitalizing the loans it took out to pay for the deal.

"Essentially what they're doing with the refinancing is they're paying out the equity portion they invested last year in terms of a dividend," Tarantino said.

Tarantino said companies look to raise hefty debt only when they believe they have adequate cash flow to pay it down. Of course, banks must share the same confidence in order to issue the loans, Tarantino said.

"At the end of the day these people aren't stupid and they wouldn't do it if they didn't think it was worth it," Tarantino said.

The downgrade of BJ's debt, which, according to Tarantino, is approaching high-yield status, certainly isn't a plus for the company, but O'Shea, the Moody's analyst, called BJ's a strong competitor in the Northeast and said the company enjoys leading market share in terms of store locations. The company has also enjoyed "excellent operating performance" over the past several years, according to O'Shea.

Jon Seiffer, a partner at Leonard Green, said the significance of the Moody's downgrade is minimal, and said it's business as usual for BJ's, despite the large amount of new debt the company will assume. According to Seiffer, the downgrade is nothing more than a function of the new debt being borrowed.

Expansion Plans?

BJ's continued to grow early this year after it went private, opening three new East Coast locations in January. Though the company isn't pursuing a particular strategy for further growth, Seiffer said it will continue to look for new store locations.

But Brandt Leahy, a senior analyst at North Carolina-based Sageworks Capital, a financial information company, offered a different viewpoint when asked about the implications of a credit downgrade in general, though he didn't specifically comment on the BJ's situation.

"A credit downgrade is a very negative event for a company because it directly affects a business' access to capital and the rate at which they can borrow," Leahy said in an e-mail.

Interest rates on existing debt could also increase because of a downgrade, according to Leahy. And he said it can be a signal that a company's prospects are declining, or they're in a deteriorating market.

But according to the company's 2011 10-K filing, membership revenues increased every year through the recession, as did net sales. Total assets climbed from $1.9 billion in 2007 to $2.3 billion in 2011. Seiffer, at Leonard Green, expressed optimism about BJ's future.

"We're confident the credit rating will improve as the company continues to expand over the next several years," he said.

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