April 18 (The following statement was released by the rating agency)
Fitch Ratings has downgraded Tesco PLC's (Tesco) Long-term Issuer Default Rating
(IDR) and senior unsecured rating to 'BBB+' from 'A-'. The Short-term rating has been affirmed
at 'F2'. The Outlook on the Long-term IDR is Stable.
The downgrade reflects Tesco's heightened business risk profile as highlighted
in its weaker than expected FY13 (financial year ending 23 February 2013)
results with a 13% drop in group trading profit. Credit metrics are now more
commensurate with a 'BBB+' rating including its FFO lease-adjusted net leverage
which Fitch expects to be around 3.0x or the equivalent lease-adjusted net
debt/EBITDAR at around 2.7x. The group has been negatively impacted not only in
the UK but also in its International business. This is reflective of a difficult
consumer environment, increased competition in the UK and also the increased
structural challenges facing large food retailers across Europe.
These structural challenges include competition from specialist retailers and
the internet on the food retailers' non-food offer, the preference for
convenience store format compared with large hypermarket stores, the price
transparency available to consumers as a result of the internet and that
consumers are less loyal to brands/retailers, switching between retailers for
better promotions or deals.
KEY RATING DRIVERS
UK Execution Risks:
The key challenge for Tesco remains the successful execution and improvement of
its core UK operation, in similar ways that Carrefour SA ('BBB'/Stable) had and
is still facing in its core French market - combined with the challenges facing
the non-food business. Like Carrefour, these structural issues and the changing
consumer trends have meant that Tesco has had to continue reinvesting in its
business. Tesco has admitted that the UK business was under-invested for a
number of years and a plan needs to be put in place to turn the business around.
In January 2012, Tesco committed over GBP1bn in revenue and capital investments
as it embarked on its plan to improve competitiveness with an aim of halting a
loss of market share (albeit marginal) to competitors like Sainsbury's and Asda.
The plan focused on more staff, refurbished stores, revamped food range and
price initiatives. This has led to a deliberate and permanent downward reset of
its UK margins to 5.2% in FY13 from 5.8% in FY12. Fitch expects profitability in
the UK will therefore remain below historical levels albeit above industry
Poor International Performance:
Fitch notes ongoing price pressures in the food retail industry in Europe due to
government austerity measures, high unemployment rate as well as intense
competition in the non-food segment from specialist retail chains and the
development of internet shopping. Although the group's European business
represents about 14% of group sales and 10% of group trading profit, this
business division has nonetheless contributed to the weak FY13 financial
results. In Asia, Tesco has been negatively impacted in Korea and China with the
trading margin down by 105bp to 5.76% in FY13. While growth will likely resume
in some of these markets, especially in Asia, Tesco needs to demonstrate that it
can improve profit margins in its international operations.
Prudent Financial Policy:
Fitch expects a stabilisation in Tesco's metrics over the next 18 months, as
reflected in the Stable Outlook. Moreover, Fitch views positively Tesco's more
cautious financial strategy, as evidenced by the group's stable dividend payout
ratio and the focus on cash flow with strict capex discipline. Tesco has
indicated that there is limited scope for share buybacks until the business is
stabilised and credit metrics restored.
Tesco US Exit:
Tesco has confirmed the exit of its Fresh & Easy US business where it made a
cumulative loss of GP782m since its first store was opened in November 2007,
with cumulative capex of GBP1.2bn as of H112. The exit will benefit Tesco's
financial profile by halting several years of operating losses and would allow
the retailer to focus on addressing more pressing issues in its home market and
other key markets.
Positive: Future developments that could lead to a positive rating action
- Group EBIT margin above 5%, mainly reflecting the success of the turnaround of
Tesco's operations in UK; together with positive FCF generation on a sustainable
- FFO fixed charge cover sustainable at or above 4.0x
- Retail-only (excluding Tesco bank) FFO lease-adjusted net leverage trending
towards 2.5x or lease -adjusted net debt/EBITDAR of 2.0x
Negative: Future developments that could lead to a negative rating action
- Group EBIT margin decreasing to below 4.0%
- Continued loss of market share
- FFO fixed charge cover below 3.0x
- Retail-only (excluding Tesco bank) FFO lease-adjusted net leverage above 3.5x
or lease-adjusted net debt/EBITDAR increasing to above 3.0x
- The emergence of shareholder pressure for shareholder-friendly measures
FULL LIST OF RATING ACTIONS
Long-term IDR: downgraded to 'BBB+' from 'A-'; Outlook Stable
Senior unsecured debt: downgraded to 'BBB+' from 'A-'
Short-term IDR: affirmed at 'F2'
Tesco Treasury Services PLC
Senior unsecured debt guaranteed by Tesco PLC: assigned 'BBB+'
Short-term debt guaranteed by Tesco PLC: affirmed at 'F2'