TEXT-S&P cuts Co-operative Group Ltd

Overview
-- We believe that the food retail business of U.K.-based Co-operative
Group Ltd. (the Co-operative) will continue to face declining sales and
profits in 2013, amid difficult trading conditions and intense market
competition.
-- We forecast that the Co-operative's credit metrics will deteriorate to
below the levels we consider commensurate with an investment-grade rating in
the remainder of 2012 and into 2013.
-- We are therefore lowering our long-term corporate credit and issue
ratings on the Co-operative to 'BB+' from 'BBB-'.
-- The stable outlook reflects management's commitment to reduce debt,
and our view that the Co-operative has sufficient financial flexibility to
maintain credit metrics commensurate with the 'BB+' rating.
Rating Action
On Oct. 19, 2012, Standard & Poor's Ratings Services lowered its long-term
corporate credit rating to 'BB+' from 'BBB-' on U.K.-based retailer
Co-operative Group Ltd. (the Co-operative). The outlook is stable.

We also lowered to 'BB+' from 'BBB-' our issue rating on the Co-operative's
GBP450 million and GBP350 million unsecured notes, due 2020 and 2026
respectively,
in line with the corporate credit rating. The recovery rating on the notes is
'3', reflecting our expectation of meaningful (50%-70%) recovery in the event
of a payment default.

At the same time, we removed the corporate credit and issue ratings from
CreditWatch, where they were placed with negative implications on July 23,
2012.

Rationale
The downgrade reflects our view that the Co-operative's sales and profits in
its food retail business will continue to decline, largely due to the
pressures on consumer spending amid the continued weak macroeconomic
environment in the U.K. that we forecast over 2013. The Co-operative's
operating performance has also been adversely affected by intense price
competition, exacerbated by the growing presence of discount retailers and
larger supermarket chains' expansion into convenience food retailing in the
U.K. In this context, and following the Co-operative's weak retail performance
in the six months to June 30, 2012, we forecast that the trading group's
Standard & Poor's-adjusted EBITDA margin will fall to less than 7% in 2012 and
remain at this level in 2013.

We believe that the additional bank branches from the Lloyds Banking Group
(A-/Stable/A-2) could enhance the Co-operative's size and brand recognition in
the U.K. as it will increase the group's banking network to almost 1,000
branches across the U.K., representing nearly 10% of the U.K.'s entire bank
network and serving 11 million customers. However, we do not anticipate that
this will improve our assessment of the Co-operative's "satisfactory" business
risk profile, which continues to be underpinned by the group's position as the
fifth-largest food retailer in the U.K. market. On the other hand, we believe
that the Co-operative will maintain its "satisfactory" business risk profile,
in spite of depressed consumer spending in the mature and competitive U.K.
food retail market and the group's vulnerability to competitor discounting. We
continue to view the group's financial risk profile as "significant," despite
the likely deterioration in the group's credit metrics in 2013. The
Co-operative's financial risk profile benefits from its "adequate" liquidity
as defined in our criteria, and its large asset portfolio that could be
monetized to reduce the group's financial debt.

We understand that the Co-operative may issue GBP350 million of perpetual
subordinated debt in 2013, to fund the initial consideration for the proposed
acquisition of additional bank branches. The impact of the subordinated debt
on the Co-operative's capital structure will depend on the terms of the debt
issue. However, even without this additional debt, the group's declining
retail sales and profits alone will increase financial leverage over the
remainder of 2012 and 2013.

We factor into our forecasts of the trading group's credit metrics some plans
by management to reduce debt through disposing of some smaller noncore trading
businesses and freehold property, closing loss-making stores, reducing capital
expenditures (capex) and member payments, among other measures. Despite the
likely reduction in indebtedness through these measures, we believe that the
combination of continued weak market conditions affecting the group's U.K.
food retail business and the increase in debt due to the proposed acquisition
of bank branches will weaken the Co-operative's credit metrics to below the
levels we consider commensurate with an investment-grade rating. We consider
that even without the additional debt from the perpetual subordinated
instrument to be issued in 2013, the Co-operative's ratio of Standard &
Poor's-adjusted debt to EBITDA will likely exceed 4x at year-end 2012 and in
2013, with funds from operations (FFO) to debt at the high end of the 15%-20%
range.

Liquidity
We assess the Co-operative's liquidity as "adequate" under our criteria, and
calculate that liquidity sources will exceed liquidity needs by more than 1.2x
over the next 12 months. We also anticipate that the group will be able to
maintain adequate headroom under its financial covenants.

Following the Co-operative's completion of a GBP950 million refinancing in July
2012, we estimate the trading group's liquidity sources over the next 12
months to be in excess of GBP1.3 billion. These include:
-- Ongoing cash balances of about GBP300 million, factoring in working
capital movements;
-- Ongoing availability of at least GBP500 million under the credit
facilities maturing in 2017 at the earliest; and
-- FFO of just less than GBP500 million.

We estimate the trading group's liquidity needs over the next 12 months to be
less than GBP500 million, comprising:
-- Capex of less than GBP400 million; and
-- Member payments of approximately GBP50 million-GBP70 million.

The trading group has no material short-term debt maturities, following the
completion of its refinancing in July 2012. We anticipate that the initial
consideration payable for the potential acquisition of the Lloyds Banking
Group branches in 2013 will be covered by perpetual subordinated debt of GBP350
million, which has been underwritten by the Lloyds Banking Group.

Recovery analysis
The issue rating on the Co-operative's GBP450 million and GBP350 million
unsecured
notes due 2020 and 2026 is 'BB+', in line with the corporate credit rating.
The recovery rating on these unsecured notes is '3', indicating our
expectation of meaningful (50%-70%) recovery for debtholders in the event of a
payment default.

In line with our recovery rating criteria, we generally cap our recovery
ratings on unsecured debt issued by corporate entities with corporate credit
ratings of 'BB-' or higher at '3' to reflect our view that their recovery
prospects are at greater risk of being impaired by the issuance of additional
priority or pari passu debt prior to default.

The issue and recovery ratings on the unsecured debt instruments are supported
by our valuation of the Co-operative as a going concern. Our recovery analysis
is also underpinned by the large portfolio of stores owned by the group.
However, the ratings also reflect the unsecured status of the notes.

To calculate hypothetical recoveries, we simulate a payment default. We
believe that the key risks that the company faces relate to continued declines
in sales and profits, as well as increasing competition from large grocery
stores moving into convenience food retailing. In our recovery scenario,
rising food commodity prices and energy costs could also reduce the group's
profit margin. Our hypothetical default scenario assumes a payment default in
2017, which corresponds to the maturity year of the GBP950 million bank
facilities. In evaluating recovery prospects for noteholders, we believe that
the business would retain value as a going concern in the event of a default
based on its well-recognized brands, its high street presence, and its
diversified business model with a presence in more predictable nonfood
businesses.

In calculating our estimated stressed enterprise value of the Co-operative, we
exclude any value from the group's financial services business Co-operative
Financial Services (CFS; comprising Co-operative Bank and Co-operative
Insurance). Therefore, we do not include any debt facilities that sit at CFS
in our post-default recovery waterfall. We estimate the stressed enterprise
value of the Co-operative, excluding CFS, at approximately GBP1.9 billion,
equivalent to 6.0x stressed EBITDA.

After deducting priority liabilities--comprising mostly enforcement costs,
finance leases, 50% of pension liabilities, and about GBP240 million of secured
debt--we see about GBP1.4 billion remaining for unsecured debtholders. We
envisage GBP2.0 billion of unsecured debt outstanding at default (including six
months' prepetition interest) assuming that the group refinances debt maturing
on the path to default. On this basis, our recovery expectations for the
unsecured notes are at the high end of the 50%-70% range.

Outlook
The stable outlook reflects our view that the Co-operative will be able to
maintain its credit ratios through 2013, within the corridor of FFO to debt at
the higher end of 15%-20% and adjusted debt to EBITDA ratios between
4.0x-4.5x, which are commensurate with its BB+ rating. We anticipate that the
Co-operative will maintain these credit metrics despite the weak trading
conditions we forecast over 2013, on back of management's plan to reduce debt
through disposals, and reducing capex and member payments.

We could lower the rating further if the Co-operative appears unable keep
credit metrics in line with our guidelines for the rating. This could arise,
in our view, if management is unable to execute its plan to reduce leverage,
or if there is a sharper-than-anticipated deterioration in operating
performance at the group's food retail or specialist businesses.

In our view, we are unlikely to upgrade the Co-operative in the near term. We
could raise the ratings, however, if the Co-operative turns around the current
negative trend in its operating performance and improves its financial metrics
to FFO to debt of more than 25% and debt to EBITDA of less than 4x, on a
sustainable basis.

Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit
Portal, unless otherwise stated.
-- Methodology And Assumptions: Liquidity Descriptors For Global
Corporate Issuers, Sept. 28, 2011
-- Principles Of Credit Ratings, Feb. 16, 2011
-- Use of CreditWatch And Outlooks, Sept. 14, 2009
-- Criteria Guidelines For Recovery Ratings On Global Industrials
Issuers' Speculative-Grade Debt, Aug. 10, 2009
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded,
May 27, 2009

Ratings List
Co-operative Group Ltd.
Corporate Credit Rating BB+/Stable/-- BBB-/Watch Neg/--
Senior Unsecured
GBP350 mil 6.25% nts due 07/08/2026 BB+ BBB- /Watch Neg
Recovery Rating 3
GBP450 mil 5.625% nts ser A due BB+ BBB- /Watch Neg
07/08/2020
Recovery Rating 3