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DXP Enterprises Inc -- Moody's assigns B2 rating to DXP Enterprises' new term loan; negative outlook

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Rating Action: Moody's assigns B2 rating to DXP Enterprises' new term loan; negative outlook

Global Credit Research - 08 Dec 2020

New York, December 08, 2020 -- Moody's Investors Service ("Moody's") assigned a B2 rating to DXP Enterprises Inc's (DXP) proposed $330 million senior secured term loan due 2027 and affirmed its existing ratings, including the B1 Corporate Family Rating (CFR), B1-PD Probability of Default Rating and B2 rating on its existing senior secured term loan. The SGL-2 Speculative Grade Liquidity Rating is unchanged. The outlook was changed to negative from stable. The proceeds of the proposed term loan will be used to refinance its existing term loan facility and for general corporate purposes.

"The change in DXP's rating outlook to negative reflects the combined effects of the weak operating environment and increased debt from the term loan issuance," stated James Wilkins, Moody's Vice President -- Senior Analyst. "DXP's ratings were affirmed based on our expectation that DXP's revenue and cash flow will grow in 2021, enabling its credit metrics to recover to levels supportive of its ratings."

Assignments:

..Issuer: DXP Enterprises Inc

....Senior Secured Term Loan, Assigned B2 (LGD4)

Affirmations:

..Issuer: DXP Enterprises Inc

.... Probability of Default Rating, Affirmed B1-PD

.... Corporate Family Rating, Affirmed B1

....Senior Secured Term Loan, Affirmed B2 (LGD4)

Outlook Actions:

..Issuer: DXP Enterprises Inc

....Outlook, Changed To Negative From Stable

RATINGS RATIONALE

DXP has proposed the issuance of a new $330 million senior secured term loan due 2027 to refinance its existing term loan due 2023 that had $217.5 million outstanding at September 30, 2020. The proposed senior secured term loan is rated B2, one notch below the CFR, reflecting the lower priority of its claim relative to the borrowings under the ABL revolving credit facility. Under a distressed scenario the collateral available to term loan lenders likely will not be sufficient to cover the principal amount of the loan. Accordingly, Moody's believes the B2 rating on the term loan is more appropriate than the rating suggested by Moody's Loss-Given-Default (LGD) methodology.

DXP's negative outlook incorporates the uncertainty over the pace of a recovery in DXP's revenue and profit margins in 2021 as well as the impact of the incremental debt on DXP's credit metrics. The company's credit metrics have weakened in 2020 due to lower revenue and profit margins, and the refinancing transaction will increase debt by approximately 50 percent, further increasing gross leverage.

DXP's B1 CFR reflects its high exposure to cyclical end markets, modest scale for a distribution company with competitors having greater resources, single digit operating margins (driven by its distribution business model) and a history of acquisitions. The oil & gas, chemical and other industrial markets in North America account for a significant portion of its revenue. DXP's revenue declined by almost 30% year-over-year in the second and third quarters of 2020 after the coronavirus pandemic resulted in a dramatic fall in spending by oil & gas companies and lower demand in other end markets. The oil & gas market, which accounted for 43% of revenues in 2019, provided only 29% of third quarter 2020 revenue. The company, which intends to diversify its revenue further in markets with more stable demand, has a history of bolt-on acquisitions that increase its geographic footprint or adds to its core product lines. Historically, it has partially funded acquisitions with equity, limiting the impact on its leverage. The company's last two acquisitions completed in the first quarter 2020 (Turbo Machinery Repair and Pumping Systems, Inc.) were funded with existing cash balances ($14.2 million) plus $2.0 million of DXP common stock.

The company's margins do benefit from certain value added activities. The rating has also been supported by moderate leverage and interest coverage credit metrics through the industry cycle, the diversity of its customer base and product lines, broad North American presence, positive free cash flow generation through cycles (as a result of low capital expenditure requirements, no common dividend and release of cash from working capital if revenue declines), a steady contractual, fee-based business in the Supply Chain Services segment and broad supplier base.

The SGL-2 Speculative Grade Liquidity Rating reflects the company's good liquidity supported by Moody's expectations that it will generate positive free cash flow, a cash balance ($97 million as of September 30, 2020) and undrawn ABL revolving credit facility. DXP is also in the process of refinancing its ABL revolving credit facility with a new $135 million facility maturing in five years. The existing $135 million revolver, which is subject to a borrowing base and was undrawn as of September 30, 2020, had availability of $114.3 million. DXP has some seasonality to its cash flows and working capital is a use of cash when revenue grows (working capital was a source of $76 million of cash in the second and third quarters of 2020 when revenue dropped). The company will be subject to two financial covenants -- a maximum net secured leverage ratio under the proposed term loan agreement and a springing fixed charge coverage ratio of 1.0x under the proposed revolving credit facility. Moody's expects the company will remain in compliance with the financial covenants through 2021. The company is required to make principal repayments totaling one percent per year of the original term loan principal ($3.3 million per year). Following the refinancing transactions DXP will have no significant maturities until the new revolver matures in 2025.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

An upgrade in the company's ratings is constrained by its modest scale. However, an upgrade could be considered if the company's EBITA grew considerably to more than $300 million (2019 EBITA was $86 million), operating margin exceeds six percent on a sustained basis, and debt to EBITDA is less than 3.0x. The ratings could be downgraded if revenues decline meaningfully, operating margins fall below 4%, leverage exceeds 4.5x or the company does not produce positive free cash flow.

The principal methodology used in these ratings was Distribution & Supply Chain Services Industry published in June 2018 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1121974. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

DXP Enterprises Inc (NASDAQ: DXPE), headquartered in Houston, TX, is a distributor and service provider to the energy industry and industrial customers. It distributes maintenance, repair, operating (MRO) products and equipment, and provides integrated supply and other services. DXP also assembles rotating equipment packages and engages in limited pump manufacturing.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

James Wilkins Vice President - Senior Analyst Corporate Finance Group Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Steven Wood MD - Corporate Finance Corporate Finance Group JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Releasing Office: Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653

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