October 5, 2017 / 11:39 AM / a year ago

Fitch Affirms Sodexo at 'BBB+'; Outlook Stable

(The following statement was released by the rating agency) LONDON, October 05 (Fitch) Fitch Ratings has affirmed France-based food service provider Sodexo SA's Long-Term Issuer Default Rating (IDR) and senior unsecured ratings at 'BBB+'. The Outlook remains Stable. The affirmation and Stable Outlook are supported by Sodexo's steady business model, which has proven quite resilient through economic cycles. Sodexo's business model is characterised by good geographic diversification, a large non-concentrated customer base, high retention rates and a long-term trend of increased outsourcing by both public- and private-sector clients. We expect the company to be able to offset cost pressure from minimum wage increase thanks to progress on its "Adaptation and Simplification" cost rationalisation programme and to deliver steady profit margin increases through to the financial year ending August 2020 (FY20). Sodexo generates good cash flow, which we expect it to continue deploying towards bolt-on M&A and shareholder remunerations. As a result, our rating case assumes broadly stable to moderately improving credit metrics. KEY RATING DRIVERS Steady Business Model: Fitch expects group revenue to steadily rise towards EUR22 billion by FYE19. The growth will be underpinned by continued organic growth as well as some acquisitions. With its large scale, Sodexo will always encounter softness in certain markets and sectors. However, strong diversification reduces this impact. Given the recent trends towards further outsourcing, and growth in some emerging markets, we expect Sodexo's diversification to further improve, strengthening the overall business profile. The new segmentation lines and potentially increased acquisition activity bring some execution risks, but we are confident in management's ability to deliver successfully. High Retention Rates: Sodexo has proven its resilience through the cycle, reducing costs and preserving profitability. In the food service business, the quality of product and service is of paramount importance, and Sodexo has secured its number-two position in food services through high retention rates (93.1% at FYE16) and contracted revenue resulting in low renewal risk. Improving Profitability: Sodexo's underlying operating margins (EBIT) have been steadily improving over the past four years, ranging between 4.2%-5.7%. The group expects that the new Adaptation and Simplification Program will lead to annual cost savings of about EUR220 million. In our rating case projections, we forecast that margins will improve towards 6.7% by FYE20. The improvements will be driven by some of the scale benefits from organic growth, but we also see some of the benefits from the recently completed Adaptation and Simplification Program. This will be within our current profitability guidance for a positive rating action ("sustained group operating margin between 6.5%-7.5%"). Steady FCF: We forecast that the FCF margin will remain steady at slightly above 2% from FY18 onwards, improving from historical levels of about 1.3%-1.5% following the lower cost base after completion of the Adaptation and Simplification Program. It has been lower in recent years, and will remain so in FY17 due to the one-off costs associated with implementing this programme. Sodexo has the ability to reduce leverage, due to this good cash conversion, but much of the cash is either used for acquisitions, or given the absence of acquisitions in recent years, share buybacks. Increased Debt Reduces Flexibility: We expect Funds from operations (FFO) adjusted gross leverage to increase to 3.1x at FYE17 from 2.6x at FYE16. While profitability has improved, a higher leverage is driven by increased gross debt levels, following the issuance of the EUR800 million notes maturing in 2027. We expect some deleveraging to come as a result of the improving profitability leaving leverage levels comfortable at the current rating level. However, with planned acquisitions and/or potentially further share buybacks, deleveraging prospects are now slower than what we previously forecasted. We do not include drawings under the commercial paper programme in our adjusted gross debt amount. DERIVATION SUMMARY Sodexo is rated one notch below its closest peer Compass Group Plc (A-/Stable). Compared to Compass, we forecast that Sodexo's leverage will be slightly higher at FY17 and that its EBITDA margin will remain approximately 200bp lower. We also view Compass's business profile as marginally stronger. Compass is further along its Management and Performance (MAP) framework which has led to margin benefits enabling the group to reinvest in the group, contributing to stronger organic growth. Sodexo's profit margins should improve following the completion of its Adaptation and Simplification Program. Peer Elior SA (BB/Stable) has a weaker business and financial profile than Sodexo and Compass, which is highlighted by the multi-notch rating level differential. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - organic revenue growth of 0.8% in FY17; improving to 1.8%-1.9% from FY18 onwards, which will be complemented by some further top-line growth due to acquisitions; - EBIT margin of 6.1% in FY17 improving towards 6.6% by FY19; - slight cash working-capital outflows in the future, driven by continued top-line growth; - capex at 1.7% of sales in FY17; increasing to 1.8% of sales from FY18 onwards; - common dividends of EUR359 million in FY17, increasing annually towards EUR500 million by FY20; - acquisitions of EUR400 million in FY17, and annual acquisition expenditure of about EUR250 million thereafter; - share buybacks in FY17 equal to the recently completed EUR300 million buyback programme, in future years, about EUR200 million; - restricted cash remains at EUR815 million. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action -Sustained deleveraging through debt repayment leading to FFO adjusted gross leverage falling below 3.0x on a sustained basis; -FFO fixed charge cover ratio remaining above 5.0x; -Evidence that cost efficiencies are improving operating margins sustainably leading to a sustained group operating EBIT margin between 6.5%-7.5% Future Developments That May, Individually or Collectively, Lead to Negative Rating Action -Evidence of significant non-renewal of contracts and/or negative like-for-like sales growth along with EBIT margin erosion below current levels; -FFO adjusted gross leverage above 3.5x; -FFO fixed charge cover ratio below 4.0x LIQUIDITY Healthy Liquidity: Fitch continues to view Sodexo's liquidity as strong and we assume that the company will maintain adequate financial flexibility over the medium term. At FYE16 it had about EUR1,375 million of available cash. Together with good FCF generation and access to EUR531 million and USD709 million of committed credit facilities, this is more than sufficient to cover short-term maturities. The group also has enhanced liquidity following the commencement of an unguaranteed EUR1,000 million commercial paper programme earlier this year (increased to EUR1,400 million in September 2017). Contact: Principal Analyst Patrick Durcan Analyst +44 20 3530 1298 Supervisory Analyst Giulio Lombardi Senior Director +39 02 8790 87214 Fitch Italia S.p.A. via Morigi 6 20123 Milan Committee Chairperson Sophie Coutaux Senior Director +33 1 44 29 91 32 Summary of Financial Statement Adjustments - Fitch has adjusted the debt by adding 8x of yearly operating lease expenses related to long term assets of EUR111 million. Fitch has reclassified EUR15 million of cash related to improving the liquidity of shares and regulation of quotations as restricted and hence not readily available for debt service. Fitch includes costs associated with Adaptation and Simplification Program below FFO. Media Relations: Adrian Simpson, London, Tel: +44 203 530 1010, Email: adrian.simpson@fitchratings.com. Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. Applicable Criteria Corporate Rating Criteria (pub. 07 Aug 2017) here Country-Specific Treatment of Recovery Ratings (pub. 18 Oct 2016) here Non-Financial Corporates Notching and Recovery Ratings Criteria (pub. 16 Jun 2017) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. 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