Standard & Poors lowered the issue credit rating of Fitness International LLC, the parent of LA Fitness, to ‘CCC+’ from ‘B”B-‘ with a developing outlook.

The issuer credit rating was lowered to ‘B-‘ from ‘B+’ and recovery rating remains ‘2’. At the same time, S&P removed all of the ratings on the company from Credit Watch, where they were placed with negative implications on March 20, 2020.

S&P said, “The downgrade reflects our assumption that LA Fitness will experience a spike in leverage and a significant cash burn rate while gyms are closed and possibly during the early months of re-openings, which could use a substantial portion of the company’s liquidity and possibly result in an unsustainable capital structure.  We assume no revenue while gyms are closed, and the beginning of recovery in the third quarter of 2020 under our base case for virus containment midyear 2020. In our base case, we estimate revenue could ramp to 50% of historical revenue in the third quarter of 2020, and improve further in the fourth quarter. It is our understanding the company had in excess of $325 million in cash on hand on April 1, 2020 after fully drawing its $400 million revolver. The company also amended its credit facility on April 7, 2020, to amend and waive certain covenants. This level of cash may be sufficient to cover the anticipated cash burn if the clubs reopen in the third quarter, but not during a prolonged period of club closures. Anticipated cash needs include debt service, and significantly reduced labor and non-rent occupancy costs while clubs remain closed. Depending upon how revenue ramps, the company may use cash for several months after clubs re-open while the company brings its employees back from furloughs, pays vendors to remain current, and brings facilities back online.

“The developing outlook means an upgrade or downgrade are equally likely over the next 12 months depending on the duration of gym closures, economic conditions, consumer behavior, and the company’s ability to preserve its liquidity. The upside reflects the possibility for leverage to improve under our midyear recovery scenario to a level in line with a higher rating. The downside reflects the possibility the company may face a near-term default, in the absence of a liquidity-enhancing transaction, under its current cash burn rate if containment and club re-openings do not occur midyear.

“We could lower our rating if we expect the company’s liquidity position to worsen, or we believe the company is likely to default or enter into a debt restructuring of some form in the next 12 months.

“Although unlikely over the next several quarters and until gyms reopen and ramp up revenue, we could consider a one-notch upgrade or more if we believe the company can sustain positive cash flow and is likely to materially reduce leverage to below 7x following containment of COVID-19.”