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Fitch Affirms Lotte Shopping at 'BBB-'; Outlook Stable
August 24, 2017 / 7:27 AM / 3 months ago

Fitch Affirms Lotte Shopping at 'BBB-'; Outlook Stable

(The following statement was released by the rating agency) SEOUL, August 24 (Fitch) Fitch Ratings has affirmed South Korea-based Lotte Shopping Co. Ltd's (Lotte Shopping) Long-Term Issuer Default Rating (IDR) and senior unsecured debt rating at 'BBB-'. The Outlook is Stable. Lotte Shopping's ratings and Outlook continue to be supported by its dominant position in Korea's department store industry and its diversified business portfolio, which encompasses major retail formats, such as department stores, hypermarkets, supermarkets, convenience stores and outlets. However we believe the rating headroom is now much reduced following weaker-than-expected operations so far in 2017 due to geopolitical issues as well as rising costs and sluggish top-line growth. KEY RATING DRIVERS Geopolitics Affect 1H17 Operations: South Korea's decision to install a US anti-missile defence system in early 2017 resulted in retaliatory measures from the Chinese government. The company had to suspend operations at 86 of its 99 Chinese hypermarkets. The halt to all group tours from China to South Korea also hurt operations at Lotte Shopping's flagship store in downtown Seoul. The geopolitical tensions worsened the already-weak operating environment for retailers in South Korea. As a result, 1H17 EBITDA from non-financial operations fell 11% yoy. Continued Uncertainty, Slight Recovery: We expect uncertainties from the tensions with China and the resulting punitive measures to continue in the short term. We believe the company may take this opportunity to restructure or even dispose of part of the unprofitable China hypermarket division. This may raise the company's restructuring costs for the whole of 2017, although the worst likely took place during 2Q17 as labour costs are likely to decline in 2H17 because a significant proportion of its employees are on leave and only eligible for 70% of the minimum wage. We believe overall profitability will slightly improve from 2H17 due to cost-cutting in its domestic department stores, a turnaround in its domestic hypermarket division, and continued robust performance in other businesses, such as its electronics retail and TV home shopping business. Weak Credit Profile to Improve: We expect Lotte Shopping's credit profile to deteriorate in 2017 because of the negative impact from the geopolitical issues and a sluggish operating environment. Adjusted net debt to EBITDAR (non-financial operations) is likely to exceed 5x in 2017 and 2018 (2016: 5.1x), the level at which Fitch may consider negative rating action. However, we expect net leverage to come down from 2018 and be in line with our guideline from 2019 due to improving operations, sizeable capex cuts and other efforts. Capex Cuts: The company has been slowing its expansion since 2015 in light of the difficult operating environment. Management says capex will be flat for 2017 and we believe capex will fall from 2018, as committed capex projects are phased out and the company opens a very limited number of new stores. As such, we have assumed flat capex for 2017 and a fall of over 20% in 2018. In addition we believe the company is also considering other options to raise cash. Limited Impact from Group Restructuring: The Lotte Group is moving towards a holding company structure to resolve its complex circular shareholdings within the group. As a result, Lotte Shopping will be split into an operating entity and investment entity, and the latter together with investment entities from two other affiliates (Lotte Food System, Lotte Chilsung Beverage) will be merged into Lotte Confectionery, which will be the holding company. If the plan is approved at a shareholders' meeting scheduled for 29 August, Lotte Shopping will sell down its stakes in various companies, including credit-card company Lotte Card and convenience store operator Korea Seven. We believe the change will have limited impact on the company's credit profile as we already base our analysis on the non-financial operations, and the exclusion of the convenience-store business will have limited impact on Lotte Shopping's credit metrics. DERIVATION SUMMARY Within the APAC retail universe Lotte Shopping is well-positioned against Lifestyle International Holdings Limited (BB+/Negative). Lotte Shopping has a larger scale, and a stronger and more-diversified market presence in various retail formats than Lifestyle. Lotte Shopping has a slightly weaker financial profile but we believe the gap in business profile justifies the one-notch differential. Lotte Shopping's credit profile is weaker compared with those of US-based investment-grade peers, such as Macy's Inc. (BBB/Negative), Kohl's Corporation (BBB/Negative) and Nordstrom, Inc. (BBB+/Stable). However, Lotte Shopping's size is similar to those of its US peers and it has a better diversified business profile, which mitigates the weaker credit profile and results in the rating differentials. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for Lotte Shopping include: - Revenue from non-financial operations to decline by 10% in 2017 due to geopolitical tensions and a weak operating environment - Domestic hypermarket operations to return to profitability in 2H17, reflecting same-store sales growth and renewal of stores - Non-financial capex to be KRW1.2 trillion in 2017 and KRW950 billion in 2018-2019 - Dividend per share to remain flat in 2017 but gradually increase from 2018 RATING SENSITIVITIES Developments that may, individually or collectively, lead to negative rating action include; - Adjusted net debt/EBITDAR from non-financial operations exceeding 5.0x on a sustained basis - EBITDAR/(interest+rental) from non-financial operations sustained below 2.0x (2016: 2.0x) - Significant margin deterioration Developments that may, individually or collectively, lead to positive rating action include; - Adjusted net debt/EBITDAR from non-financial operations remaining below 4.0x on a sustained basis - EBITDAR/(interest+rental) from non-financial operations sustained above 2.5x LIQUIDITY Adequate Liquidity: As of June 2017, Lotte Shopping's total reported debt from non-financial operations was KRW7.8 trillion. Of that amount, KRW3.1 trillion was short-term debt, which was well covered by cash and equivalents of KRW2.7 trillion and unused committed lines of KRW800 billion. We believe the company's liquidity is further supported by the company's access to various funding sources and good banking relationships as it is a major affiliate of the Lotte Group. Contact: Primary Analyst Jeong Min Pak Senior Director +82 2 3278 8360 Fitch Ratings Australia Pty., Korea Branch 9F Kyobo Securities Building 97, Uisadang-daero, Yeoungdeungpo-Gu Seoul 07327, Republic of Korea Secondary Analyst Shelley Jang Director +82 2 3278 8370 Committee Chairperson Kalai Pillay Senior Director +65 6796 7221 Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. 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