SRCL
Fitch Ratings has affirmed Recess HoldCo LLC's and First Student BidCo, Inc.'s Long-Term Issuer Default Ratings (IDRs) at 'BB-'.
Fitch has also affirmed First Student's senior secured debt at 'BB+'/'RR2'. The Rating Outlook is Negative.
The Negative Outlook incorporates remaining execution risks in balancing pricing growth with customer churn and managing cost inflation, which have driven negative FCF and credit metrics that are weak for the 'BB-' rating. Assuming good execution, Fitch projects sustainably positive but modest FCF in the FY 2025 and Fitch-calculated EBITDAR and EBITDA leverage improving to about 5.0x in FY 2025. Fitch will look for good progress on the FY 2026 bidding season, likely materializing in early 2025, as a key indicator of a strengthening financial profile. Fitch expects to resolve the Outlook in the first half of 2025.
Fitch recognizes the success to date in contract pricing and the moderating inflationary environment. The ratings also consider the fundamentally stable demand profile of school bus services and diversified large scale of operations, and are weighed against low barriers to entry on a local scale and municipal budget constraints that can lead to a price-competitive landscape.
Key Rating Drivers
Continued Execution Would Strengthen FCF: First Student has made good progress to date in achieving larger than usual price increases aimed at mitigating high cost inflation incurred over the 2021-2023 timeframe. Around 30% of contracts are renewed each year, creating a multi-year catch up period. Fitch expects most of the pricing resets to be instituted by FY 2025.
However, executing on the price and cost balance while also minimizing customer attrition, remains a risk to a sustained improvement beyond FY 2025 in First Student's cash flow profile. The company's municipality-focused customer base can be sensitive to budgetary constraints and the low-barriers to entry on a local level can lead to heightened competition.
Pricing, Cost Success Drive FCF: Provided solid execution, Fitch forecasts low but positive Fitch-calculated FCF of roughly $50 million (about 1% of revenue) in both FY 2025 and 2026, an improvement from around negative $50 million forecast in FY 2024. The fundamental stability of demand for First Student's services, ongoing implementation of inflation-linked pricing and expectations of more manageable cost inflation over the medium term would lead to a steadier cash flow profile and better support growth strategies. Fitch's forecast also incorporates a moderation in capex to around $300 million from FY 2024-2026, which is heavily maintenance-focused, from $325 million for FY 2023.
Financial flexibility is likewise expected to improve with EBITDA interest coverage strengthening from about 2.4x in FY2024 to nearly 3.0x in FY2025.
Leverage Elevated but Improving: Fitch rating case forecasts Fitch-calculated EBITDAR and EBITDA leverage to be in the mid-to-high 5.0x in FY 2024 before improving to about 5.0x in FY 2025, a level that is returning to Fitch's rating thresholds. The forecast improvement is a result of solid operating earnings growth with Fitch-calculated EBITDA approaching $600 million, up from around $510 million in FY 2024, and a notable improvement from $382 million in FY 2023. Beyond operating execution, the forecast assumes that capital deployment over the next two years neutral to mildly supportive of First Student's leverage.
Stable Demand and Multi-Year Contracts: First Student's demand profile benefits from the essential nature of student transportation services and multi-year contracts with high renewal rates. Contracts are typically structured on a per route, per hour, or per mile basis and often include price escalators and fuel purchasing provisions to account for cost inflation and fuel exposure. Customer relationships have generally been stable, with overall customer retention around 95% and an average tenure of over 10 years for around 85% of customers.
Leading Market Position: First Student is the largest provider of outsourced student transportation in North America and is estimated to be nearly twice the size of the next largest competitor. However, it competes on a local basis, typically against smaller operators or school or municipality-provided transportation services. Its large scale reduces regional and customer-specific risks and can offer some market benefits, such as the ability to move drivers to short-staffed locations, which maintains good customer relations, and economies of scale in purchasing equipment.
Derivation Summary
Fitch compares First Student with other transportation issuers such as Stericycle (BB/Rating Watch Positive), Garda (B+/Stable) and Waste Pro (B+/Stable). Similar to First Student, Stericycle, Garda and Waste Pro business profile benefits from their contracted services and relatively steady demand that are supportive of fundamentally steady cash profiles.
While Stericycle is in the process of being acquired, the 'BB' ratings reflects its strengthening cash flows after a period operational disruptions and business transformation. Garda's EBITDA leverage in the mid-6.0x and EBITDA interest coverage of 2.0x is relatively weaker than First Student's. Waste Pro's ratings also reflect its regional concentration and expectation of an active M&A appetite.
Key Assumptions
Revenue of $3.7 billion in FY 2024 and mid-single digit growth in FY 2025 and 2026, supported by strong pricing initiatives and modest volume and M&A-linked growth;
EBITDA margin expands over 100bps to 15% in FY 2025, led by pricing initiatives, and remains steady thereafter;
Capex is expected to be 7%-8% of revenues and heavily skewed toward maintenance-level spend;
Tuck-in size M&A continues, but in a credit neutral to mildly-positive manner. Fitch has not assumed voluntary debt repayment.
RATING SENSITIVITIES
Factors That Could, Individually Or Collectively, Lead To Positive Rating Action/Upgrade
Commitment to deleveraging with EBITDAR leverage and EBITDA leverage sustained below 4.0x;
Adherence to a disciplined revenue and cost management approach that enhances margin and cash flow resiliency;
FCF margin sustained above the low single digits.
For an Outlook Revision:
The Rating Outlook could be revised if First Student executes on price and operational improvements, enhancing margin and cash flow resiliency, and supporting EBITDAR leverage sustainably below 5.0x and EBITDA interest coverage durably above 2.5x
Factors That Could, Individually Or Collectively, Lead To Negative Rating Action/Downgrade
EBITDAR leverage and EBITDA leverage sustained above 5.0x;
EBITDA interest coverage below 2.5x;
EBITDA margin consistently below 10% or expectations of sustained neutral to negative FCF generation.
Liquidity and Debt Structure
Adequate Liquidity: As of March 2024, total liquidity was $566 million consisting of $61 million of available unrestricted cash and $505 million of revolver availability. Fitch does not count the restricted cash balance in its liquidity calculation. The next maturity is the $100 million of seller notes due 2025, which are issued by a holding company and Fitch considers subordinated to Recess Holdco's debt. Fitch assumes the notes will be refinanced. Term loan amortization is scheduled at $22 million per year through maturity in 2028.
Issuer Profile
First Student is the largest national provider of essential K-12 student transport services in North America, operating roughly 42,000 school buses.
Criteria Variation
Fitch does not consider the term loan C as debt for analytical purposes, which is a variation from the Corporate Rating Criteria's definition of total debt. Proceeds from the term loan C are used only to cash collateralize LCs that support the company's self-insurance program. These proceeds sit in a restricted account that is not accessible by First Student. If an LC were to be drawn, Fitch would add a corresponding portion back to total debt.
Fitch looks to its Corporate Rating Criteria dated Nov. 3, 2023, which outlines and defines a variety of quantitative measures used to assess credit risk. As per criteria, Fitch's definition of total debt is all encompassing. However, Fitch's criteria is designed to be used in conjunction with experienced analytical judgment, and, as such, adjustments may be made to the application of the criteria that more accurately reflects the risks of a specific transaction or entity.
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.
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