Fitch downgrades reception Mezzanine Holdings (dba STG Logistics) to ‘C’ on Exchange announcement

Fitch Ratings has downgraded the Long-Term Issuer Default Ratings (IDRs) of Reception Mezzanine Holdings, LLC and Reception Purchaser, LLC (dba STG Logistics, Inc.) to 'C' from 'CCC'.

The downgrade follows the company's announcement of an offer to exchange its first-lien credit facilities (revolver and term loan) into a series of first-out, second-out and third-out term facilities. Fitch views this as a distressed debt exchange (DDE) under its "Corporate Rating Criteria". As outlined in Fitch's criteria, the IDR will be downgraded to Restricted Default (RD) upon completion of the DDE and re-rated to reflect the post-DDE credit profile. Fitch has also downgraded the legacy senior secured credit facilities to 'CC' with a Recovery Rating of 'RR3' from 'CCC+'/'RR3'.

STG plans to improve liquidity and reduce refinancing risk with its pending debt and equity transactions. They include issuing new common equity and first-out debt and exchanging existing first-lien lenders into new facilities with various security interest priorities, extended maturities, and reduced cash interest with the inclusion of PIK. Fitch estimates pro forma cash will improve to approximately $265 million as of June 30, 2024, and the post-transaction cash burn rate will decrease.

Key Rating Drivers

Exchange Reduces Liquidity Issues: Fitch expects the capital raise and exchange offer to add substantial liquidity to STG's operations and support the business through at least 2025. This extension allows STG to benefit from an improvement in intermodal freight conditions from cyclical lows. Liquidity is expected to be added in the form of cash from new debt and equity, and reduced debt service cost from a reduction in cash interest, inclusion of PIK interest, and elimination of debt amortization, at least over a three-year period. The company estimates the liquidity benefit to be an incremental $300 million over the next three years. The transaction is also expected to extend all debt maturities to October 2029.

FCF Burn Eases Post-DDE: STG's post-exchange cash flow profile will be a key consideration of its post-DDE rating, and Fitch expects to have additional clarity on liquidity runway once it is finalized. Fitch previously expected a $30 million to $40 million quarterly cash burn rate which will improve but is still forecast to remain negative through 2025. We expect the freight rate environment to strengthen next year. While intermodal contracts are likely to lock in cyclically-weak rates, other portions of the business such as drayage and warehouse logistics could see early benefits.

Freight Downturn Challenges Performance: The intermodal freight environment has been weak through most of 2024, and declining rates have been a key contributor to the deterioration of STG's financial performance. Fitch continues to expect a recovery in the freight cycle as truckload capacity, a substitutive mode, continues to exit and as macroeconomic conditions remain stable. However, the timing and degree of a near-term upcycle are uncertain.

Fitch believes STG's intermodal pricing remains below the pre-Covid historical trend. Longer-term fundamentals such as truck-to-rail conversions, improving rail service and potential for an increasingly sustainability focused-shipper base still indicate growing long-term demand.

Business Model Considerations: Fitch believes STG's business model aligns more with a 'B' or better category rating. The company occupies a top-four market position as an intermodal and drayage service provider with coverage at 8 of 10 major U.S. ports and numerous inland distribution locations. Its position is supported by its end-to-end solutions for shippers that span first- to last-mile solutions, a network of third-party transport and established relationships.

The intermodal industry is highly cyclical due to its exposure to consumer and industrial markets and susceptibility to supply and demand imbalances within intermodal and truckload markets. Fitch believes the industry has limited pricing power due to its reliance on third party transporters and the availability of substitute trucking options.

Derivation Summary

STG competes in the fragmented transportation and logistics market with a number of public large-scale peers such as J.B. Hunt, Hub Group, Forward Air (B/Stable) and CH Robinson. However, many of these peers offer a variety of services beyond intermodal shipments or rail brokerage. STG's 'C' rating reflects the announced financing transaction, which Fitch classifies as a DDE.

Key Assumptions

• STG completes a DDE in line with current expectations. This includes a large liquidity injection at the time of close and debt service savings over the next few years;
• Fitch calculated EBITDA reaches a low point of around $15 million in 2024;
  
• SOFR follows the forward curve, stepping down to around 3.5% in 2025;
  
• Financial performance will remain weak in the near term and cash flow will be negative.
  

Recovery Analysis

The recovery analysis assumes that STG would be reorganized as a going concern in bankruptcy rather than liquidated. We have assumed a 10% administrative claim.

Fitch estimates STG's GC EBITDA at $135 million. The GC EBITDA estimate reflects Fitch's view of a sustainable, post-reorganization EBITDA level upon which we base the enterprise valuation. This estimate reflects an extended downturn in the freight cycle and competitive pricing pressures leading to multi-year cash flow pressures. It also reflects corrective measures taken in the reorganization to offset the adverse conditions such as cost cutting, contract repricing and prospective industry recovery.

Fitch assumes STG would receive a GC recovery multiple of 4.0x in this scenario. This multiple is applied to the GC EBITDA to calculate a post-reorganization enterprise value (EV). Ultimately STG's 4.0x multiple is driven by the company's size and scale and by comparable EVs among logistics providers. It also considers the valuation of the XPO intermodal acquisition completed in March 2022.

Fitch's recovery scenario assumes STG's $60 million revolver is fully drawn. These assumptions generate a 'CC' rating and an 'RR3' Recovery Rating for the pre-exchange senior secured debt.

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

Per Fitch's criteria, STG's IDR will be downgraded to RD upon the completion of the debt exchange. The IDR will subsequently be re-rated to reflect the post-DDE credit profile. Fitch currently expects the re-rated post-exchange IDR to be no higher than 'B-' given STG's weak forecasted FCF generation and high near-term leverage profile.

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

• Completion of the DDE;
• Payment default occurs.
  

Liquidity and Debt Structure

Improved Pro Forma Liquidity: As of June 30, 2024, STG had $77 million of cash and no remaining availability under it $60 million revolving credit facility. The post-transaction pro forma cash position is estimated to be approximately $265 million as of June 30, 2024.

Lease Treatment: Fitch capitalizes operating lease costs at 8.0x, consistent with our treatment for real estate assets under lease. For finance leases, Fitch utilizes the reported liability since these leases are predominately for intermodal containers, which have discounted purchase options at the end of their 4-5 year lease terms.

Issuer Profile

STG is a provider of integrated, port-to-door containerized logistic services including drayage, transloading, warehousing, fulfilment, rail brokerage and final-mile solutions. It serves the continental U.S. including major ports.

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.

MACROECONOMIC ASSUMPTIONS AND SECTOR FORECASTS

Click here to access Fitch's latest quarterly Global Corporates Macro and Sector Forecasts data file which aggregates key data points used in our credit analysis. Fitch's macroeconomic forecasts, commodity price assumptions, default rate forecasts, sector key performance indicators and sector-level forecasts are among the data items included.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' 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. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.