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July 8 (The following statement was released by the rating agency)
Fitch Ratings has assigned Swiss-based travel retail group Dufry AG's proposed EUR500m senior unsecured 2022 notes a 'BB(EXP)' expected rating. The assignment of the final rating is subject to the receipt of final documentation conforming to information already received.
The bond is being issued by Dufry Finance SCA and is rated at the same level as Dufry's Issuer Default Rating of 'BB' as it will rank equally with the company's senior unsecured debt, including its existing USD500m 2020 notes, its terms loans and its revolving credit facility. Dufry will use the proceeds to finance the acquisition of the Nuance Group, along with funds from the mandatory convertible notes and the rights issue. The increased indebtedness related to the Nuance acquisition was included in Fitch's recent rating affirmation of Dufry on 5 June 2014.
KEY RATING DRIVERS
Business Scale Strengthened
The acquisition of Nuance materially increases Dufry's market leadership and scope of operations. In the travel retail industry, Fitch views this as paramount for maintaining high quality of concessions and deriving an increasing amount of operational efficiencies.
Dufry will benefit from Nuance's complementary presence in the Mediterranean region, Asia and the US. Given that over 80% of Dufry's pipeline projects involve new concessions and expansions in these geographies, Fitch views the complementary geographic nature of the transaction as highly accretive to Dufry's long-term business development goals.
Impact on Concession Portfolio Mixed
The acquisition will allow Dufry to expand and diversify its concession portfolio and add a number of profitable contracts. We note an overall shorter concession lifetime and a higher share of concessions with maximum guaranteed payments will slightly elevate Dufry's operating leverage. However, given Dufry's historically high concession renewal rates of 80%, the curtailed concession lifetime does not materially diminish business visibility. We expect the average profitability of Nuance's concessions to converge with that of Dufry's, through discontinuation of less profitable contracts and renegotiation of new concessions with predominantly variable fee structures.
The unprofitable Australian operations of Nuance are not deemed as strategically important to Dufry, and most of these unprofitable concessions are expiring over the next quarters.
Cash Generation to Remain Strong
Given Nuance's weaker profitability, the acquisition will sustainably compress Dufry's EBITDA margins by 1%-2% below the historical average of 14%. As a result, Fitch estimates that forecast funds from operations (FFO) as a percentage of sales will be consistently below historical levels of 11%-12% by 2%-3%. However, in the absence of any major incremental capital spend above the company's target of 3.5% of sales, free cash flow (FCF) generation is projected to remain strong and expand over the rating horizon. Even with lower profitability, Dufry would still rank among the top performers in the travel retail sector such as World Duty Free.
Credit Metrics under Pressure in FY14-15
As a result of the acquisition, Fitch expects FCF as a percentage of sales to drop to below 4% (FYE13: 5.4%), with FFO adjusted leverage after dividends paid to associates at around 6.0x at FYE14 (based on actual contribution from Nuance in 2H14) and remaining above 5.5x in FY15. We consider the deterioration in credit metrics will be temporary, limited to the business integration period, which is expected to be restored in FY16 once the combined business has started generating normalised levels of cash flow.
If FFO adjusted gross leverage remains sustainably above 5.5x, for example, as a result of a more onerous integration process, weaker FCF or a delay in the equity placement as part of the financing package, this could put pressure on the ratings.
Further Debt-Funded Acquisitions Likely
In the consolidating and highly competitive travel retail industry, we expect acquisitions will remain an essential strategy to deliver growth and protect profitability. As long as future acquisitions are accretive to Dufry's internal cash generation and the company remains disciplined in its financial policy, Fitch continues to factor small add-on acquisitions into the ratings.
LIQUIDITY AND DEBT STRUCTURE
Fitch expects Dufry to maintain comfortable liquidity given its continuously strong FCF generation, absence of principal repayments until 2019 after the debt refinancing and augmented liquidity reserves under the new undrawn RCF of CHF900m.
Negative: Future developments that could lead to negative rating action include:
- FFO-adjusted leverage remaining at around 5.0x in the medium term, due to an adverse shift in the operating environment, persisting organic issues and/or continuing appetite for debt-funded acquisitions
- EBITDA margin below 12%, coupled with FCF margin below 4%, both on a sustained basis
- FFO fixed charge cover sustainably below 2.5x
Positive: Although an upgrade is unlikely before 2016, future developments that could lead to positive rating action include:
- FFO adjusted leverage declining to below 4.0x and fixed charge cover rising above 3.0x on a sustained basis