Fitch Ratings has affirmed IAA, Inc.'s Long-Term Issuer Default Rating at 'BB-'.
The Rating Outlook has been revised to Positive from Stable. Fitch has also affirmed the 'BB+'/'RR1' ratings on the company's first lien secured revolving credit facility and term loan, and the 'BB-'/'RR4' rating on the senior unsecured notes.
The revision of the Outlook to Positive is driven by lower expected leverage as a result of approximately $124 million of debt reduction in 2021 and solid operating performance through the COVID-19 pandemic. Fitch expects that adjusted leverage (total lease-adjusted debt/operating EBITDAR) will be less than the 4.0x positive rating sensitivity by YE 2021. IAA benefits from a leading market position in the salvage vehicle auction industry. The company's strong financial flexibility, cash flow generation and profitability are key drivers of the rating. Fitch also considers technological advancement in auto safety, including autonomous vehicles, to be a long-term concern.
Key Rating Drivers
Return to Growth: IAA experienced modest impacts in 2020 as the coronavirus pandemic led to widespread stay-at-home orders that reduced vehicle miles driven, resulting in lower salvaged vehicles for assignment. Revenue declined by approximately 3.7%, as volume declines were somewhat offset by stronger revenue-per-vehicle. Fitch expects that 2021 revenue will increase by approximately 20% as U.S. vehicle miles driven approach pre-pandemic levels and used car prices and percentage of total loss vehicles continue to see positive long-term trends.
Significant Financial Flexibility: Fitch views IAA's financial flexibility as a main driver of the rating. The company generated FCF margins of 16.3% in 2020 and 14.1% in 2019. Fitch estimates that the company will have FCF in excess of $200 million in 2021 with long-term FCF margins sustaining above 10% of annual revenue. Liquidity is also robust, with cash of $282 million and an upsized undrawn $525 million revolving credit facility as of Q2 2021. IAA has no material debt maturities until 2026, and internally generated cash is expected to be more than sufficient to meet debt servicing costs and invest in growth initiatives.
Moderating Adjusted Leverage: Fitch expects that IAA's adjusted leverage (total lease adjusted debt/operating EBITDAR) will decline to the high-3x range at FYE21 from approximately 4.5x at FYE20 due to increased EBITDA and a $124 million reduction in gross debt. Adjusted leverage is relatively high compared to unadjusted gross leverage (total debt/operating EBITDA) of 3.3x at YE 2020, due to the company's heavy utilization of operating leases.
Shifting Capital Deployment Priorities: In August 2021 the company's board of directors authorized the repurchase of up to $400 million of common stock through 2026, signaling a potential shift to more shareholder friendly activities after repaying approximately $124 million of term loan borrowings in April 2021. Fitch expects that IAA will deploy excess cash towards bolt-on acquisitions, technology investment and opportunistic stock buybacks through the near-term, while debt levels are slowly reduced through regular term loan amortization. The company has historically not paid common dividends.
Leading Market Position: IAA is one of the top two players in the salvage vehicle auction industry, controlling a significant share of the North American market. Its largest competitor, Copart, Inc., holds a similar share. The remaining market is somewhat fragmented and made up of smaller regional companies. Fitch does not believe there is a material risk of disruption from another competitor entering the market due to the geographic footprint and established market presence of the incumbents. However, the company derives approximately 40% of its revenue from cars sourced through three insurance companies, which exposes the company to risk from the loss of an important customer.
Positive Long-term Trends: IAA has shifted to an online-only auction model in response to the COVID-19 pandemic. The company has invested significantly in online tools and technologies that it believes will lead to revenue growth by increasing buyer confidence and improving efficiency. Additionally, IAA is taking actions to reduce overhead costs. Through the medium-term this should benefit IAA as they can better utilize capacity, expand into international markets, and increase assignment turnover.
High Profitability: IAA benefits from strong profitability, generating EBITDA margins of approximately 28% in 2020, a slight contraction from pre-pandemic levels of approximately 29%. Fitch expects that recovering auction volumes and higher used car values will result in modest EBITDA margin expansion through the near-term. The asset-light business model and moderate capex are expected to result in significant EBITDA to FCF conversion.
IAA Inc. is one of the largest salvage vehicle auction companies in the United States. The company is comparable in size and scale with Copart Inc. (NR), its largest competitor. Compared with auto retailer AutoNation, Inc. (BBB-/Positive) the company has significantly higher EBITDA and FCF margins, but also materially higher adjusted leverage and is much smaller. The salvage auction business has typically remained steady in times of economic recession, while the auto retailer industry has proven to retract sharply. No parent/subsidiary linkage, country ceiling or operating environment constraints were in effect for these ratings.
Fitch's Key Assumptions Within Our Rating Case for the Issuer
Revenue increases approximately 20% in 2021 due to recovering auction volumes coupled with greater revenue-per-vehicle;
Medium-term revenue growth in the low- to mid-single digits is driven by positive trends in vehicle miles traveled, total loss percentage and used car value;
EBITDA margins are approximately 28% in 2021, with expansion up to 30% by 2024 due to cost saving actions;
Adjusted leverage declines below 4.0x by YE 2021;
FCF is positive at around $200 million in 2021, with FCF margins sustaining above 10% through the forecast;
Capex totals around 5% to 6% of annual revenue;
Excess cash is deployed towards share repurchases and bolt-on acquisitions;
The company does not make any further debt prepayments.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Adjusted leverage (total lease-adjusted debt/operating EBITDAR) sustains below 4.0x;
FFO adjusted leverage sustains below 5.0x;
The company increases its geographic diversification and reduces customer concentration.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Adjusted leverage sustains above 5.0x;
FFO adjusted leverage sustains above 6.0x;
FCF margins sustain in the low-single digits.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Sufficient Liquidity: IAA's liquidity as of June 27, 2021 consists of $282 million of cash and full availability of a $525 million revolving credit facility. Fitch believes the company's internal liquidity and significant cash flow will allow them to meet debt servicing costs, working capital needs and investment priorities without additional funding.
Debt Structure: The company's capital structure consists of a $525 million revolving credit facility, a $650 million Term Loan B, and $500 million of unsecured notes.
IAA entered a new credit agreement in April 2021 that replaced their previous revolver and term loan. The new credit facility matures in April 2026, with pricing of LIBOR + 37.5bps-125bps. The term loan amortizes at 0% in the first year from issuance, 1.25% annually for the second and third years, and 1.875% thereafter until maturity. The unsecured bonds are priced at 5.5% and mature in June 2027.
IAA, Inc. is leading provider of total loss solutions and digital salvage vehicles auctions. The company was spun-off of KAR Auction Services in June 2019. Approximately 88% of 2020 revenue was generated in the United States with the largest international markets being Canada and the UK.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
RATING ACTIONSENTITY/DEBT RATING RECOVERY PRIOR
IAA, Inc. LT IDR BB- Affirmed BB-
LT BB+ Affirmed RR1 BB+
LT BB- Affirmed RR4 BB-
VIEW ADDITIONAL RATING DETAILS
Additional information is available on www.fitchratings.com
The rated entity (and/or its agents) or, in the case of structured finance, one or more of the transaction parties participated in the rating process except that the following issuer(s), if any, did not participate in the rating process, or provide additional information, beyond the issuer's available public disclosure: IAA, Inc.
Corporate Rating Criteria (pub. 21 Dec 2020) (including rating assumption sensitivity)
Corporates Recovery Ratings and Instrument Ratings Criteria (pub. 09 Apr 2021) (including rating assumption sensitivity)
Sector Navigators - Addendum to the Corporate Rating Criteria (pub. 01 May 2021)
Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s).
Corporate Monitoring & Forecasting Model (COMFORT Model), v7.9.0 (1)
Dodd-Frank Rating Information Disclosure Form
IAA, Inc. EU Endorsed, UK Endorsed