TEXT-Fitch rates LLC O'KEY's bonds 'B+'
Dec 18 - Fitch Ratings has assigned Russia-based retailer LLC O'KEY's (O'KEY) five-year RUB3bn domestic bond a local currency senior unsecured rating of 'B+' with a Recovery Rating of 'RR4', and a National Long-term Rating of 'A+(rus)'. The bond (02 series) is the first tranche issued under the RUB8bn exchange-traded ruble bond issue programme registered in October 2012 and the rating is in line with the 'B+(EXP)' rating assigned to the programme. The notes are structured as unsecured, with surety of CJSC Dorinda, the group's key asset holder, and do not contain any financial covenants. They carry a coupon rate of 10.1% per annum payable on a semi-annual basis and fixed up to the put option date of 17 December 2015. The bonds will mature on 12 December 2017. Fitch understands that O'KEY will mainly use the bond proceeds to fund a capex programme. KEY DRIVERS: Strong Russian Hypermarket Operator The ratings reflect O'KEY Group S.A.'s strong position in the growing hypermarket food retail segment in Russia and its management expertise. The group's hypermarket format enables it to take advantage of the shift in Russian food retailing towards more modern retail chains. The ratings also reflect the group's small scale compared with other listed and international leading food retail operators in Russia. High-End Positioning The group's operating performance is at the high end of the main food retailers in terms of sales/sq. m and EBITDA margin. However, Fitch believes that the group's exposure to the hypermarket segment, its more upmarket product range and non-food operations, plus its development in secondary cities make O'KEY more vulnerable to a potential worsening of the macroeconomic environment than discounters. Tougher Competition Among Hypermarkets Intensifying competition means more pressure on retailers' operating margins in general. However, Fitch expects that the group's expansion will enable O'KEY to reinforce its purchasing power over suppliers. Negative Free Cash Flow The company aims to be in 25 large cities by 2015 (17 as of end-2011). Rapid expansion requires investment in store openings as the company grows through both owned and leased stores. Consequently, Fitch expects the group's FCF to remain negative in the coming years. Its growth plans entail execution risks in the medium term, such as finding new profitable locations with decent infrastructure, being able to get local authorisation on time or find new logistics partners with the same good level of execution. Capex Partially Internally Financed Fitch expects the group to finance around 58% of capex by internal free cash flow. O'KEY will need to raise new long-term debt to sustain its developing programme at the current level. Fitch notes that a large part of capex is discretionary as it is related to opening new stores, and that maintenance and committed capex are relatively low. Operating Leases Increase Leverage O'KEY is expanding its hypermarkets and supermarkets through owned and leased stores, with a 50/50 split over time. As a result, Fitch expects the group's operating leases to increase with the expansion programme. Fitch expects O'KEY lease-adjusted net debt/FFO to increase towards 3.5x on average in the next two years, which is in line with the group's ratings. RATING GUIDELINES Future developments that may, individually or collectively, lead to positive rating action include - O'Key showing solid execution of its expansion plan - The group's capacity to show positive like-for-like sales growth - Maintaining the group's EBITDA margin of at least 7.5%-8%. Fitch acknowledges that an improvement in the group's free cash flow would be viewed as a supplementary rating positive factor. Fitch also expects the group's size to reach at least EUR500m in EBITDA terms. In terms of leverage, for a 'BB-' rating Fitch expects an adjusted net debt/FFO ratio falling permanently towards 2.5x and FFO/fixed charge >3.5x. Future developments that may, individually or collectively, lead to negative rating action include: - A sharp contraction relative to its peers of like-for-like sales and EBITDA margin erosion (7%) combined with FFO adjusted net leverage remaining above 4x (3.5x on EBITDAR basis). Additional information is available on www.fitchratings.com. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings. Applicable criteria, 'Corporate Rating Methodology' dated 8 August 2012, are available at www.fitchratings.com. Applicable Criteria and Related Research: Corporate Rating Methodology
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