Fitch changes O'key outlook to 'positive' from 'stable'; affirms 'B+" rating
LONDON/MOSCOW. Dec 18 (Interfax) - Fitch Ratings has revised Russia-based food retailer O'key Group S.A.'s (O'key) Outlook to Positive from Stable, the agency said in a press release.
Its foreign and local currency Long-term Issuer Default Ratings (IDRs) have been affirmed at 'B+'.
Fitch has also affirmed LLC O'key's senior unsecured debt at 'B+' with a Recovery Rating of 'RR4'. The National Long-term rating has been upgraded to 'A(rus)' from 'A-(rus)'.
The revision in the Outlook to Positive reflects O'key's improving operating performance leading to better-than-expected credit metrics for the next three years. It also reflects Fitch's confidence in management's ability to deliver on its growth plans while maintaining fairly stable credit metrics. Fitch expects O'key will continue to grow and achieve EBITDAR of near EUR500m by 2015 which, together with greater format diversification and an enlarged geographic footprint, will be more commensurate with a higher rating. Although O'key's credit metrics are currently consistent with a higher rating - in the 'BB' category - they are offset by its modest size and systemic corporate governance risks stemming from operating in Russia.
The ratings reflect O'key's strong position in the growing hypermarket food retail segment in Russia, its high profit margins and a growing presence across Russia's regions (48% of sales in St. Petersburg expected in 2013 vs. 59% in 2010). This is balanced with the group's moderate size in terms of EBITDAR and market position (sixth largest) compared with other domestic and international leading food retailers in Russia.
FY12 reflected better-than-expected credit metrics owing to lower capex. In FY12, funds from operations (FFO)-adjusted net leverage was 2.7x compared with Fitch's expectation of above 3x. FFO fixed charge cover was 2.9x. Given a smaller than expected capex programme and to reflect the current trading environment, we expect FFO-adjusted net leverage to remain within 3.0x-3.3x by 2015. Similarly, FFO fixed charge cover is expected to remain above 2.8x, which is strong for the ratings.
Fitch projects that O'key will be able to finance more than 80% of its capex needs with internally generated cash flows. O'key is, however, expected to show negative free cash flow (FCF) over the next four years averaging 2% of net sales per annum due to its large expansion programme and a dividend payout of up to 25% of group's net profit. This is mitigated by O'key's proven access to both bank and capital markets and its ability to obtain trade creditors' financing for its working capital as sales continue to grow at a solid pace.
The group's positioning in the fast-growing hypermarket format enables O'key to capture the structural shift towards modern food retail chains in Russia. Fitch notes that the group has been resilient during the 2008/9 economic downturn. In addition, the group's operating performance in terms of sales per sq m compares positively against other food retailers: RUB312,000 for O'key vs. RUB268,000 for X5 Retail Group and RUB 292,000 for Lenta in FY12.
O'key will face more intense competition from major market players, who have also aggressive expansion plans and have targeted hypermarkets as one of their areas of growth. Additionally as pricing remains the major factor for Russian customers, further expansion from competitors will translate into pressure on retailers' operating margins especially if the Russian consumer environment remains subdued next year.
Although O'key has been successful in one of the most competitive regions in Russian (St. Petersburg - 51% of group sales in 2012), there are execution risks embedded in O'key's expansion plans into Moscow and other main regions in Russia where consumer purchasing power and infrastructure are less developed compared with its core St. Petersburg's market. However, we expect that the group's expansion will enable O'key to reinforce its purchasing power over suppliers.
O'key plans to increase its selling space annually by 20%, mostly on the back of organic expansion in its core hypermarket format, continued development of its supermarket format and the launch of a new discounter format. O'key plans to open its first 100 smaller stores around 2015-16 in the Moscow region. This should result in significant growth in scale with EBITDAR projected to exceed EUR550m by 2016. Fitch will consider this factor positively for the ratings provided that management remains disciplined in its expansion strategy and maintains strong profit margins, robust cash flow from operations (after changes in working capital) and conservative credit metrics.
At end-September 2013 about 90% of O'key's debt was long-term (RUB15bn) and all of short-term debt maturities were revolving credit facilities. In addition, O'key registered a new bond programme with a total value of RUB25bn including six tranches (RUB3bn-5bn) of five-year maturity. In October 2013, O'key placed a tranche of RUB5bn. Combined with strong operating cash flow expected in FY13-14 we believe that liquidity sources are sufficient both for debt servicing and for financing O'key's expansion plans. Adequate liquidity is supported by available cash of RUB2.5bn as of end-June 2013 and RUB7.9bn of undrawn credit facilities as of end-September 2013.
While O'key's corporate governance is considered by Fitch to be above average relative to other Russian corporates, this is still insufficient to justify a higher rating given the lack of independence on its Board of Directors.
Positive: Future developments that could lead to a positive rating action include:-
- Solid execution of its expansion plan and positive like-for-like sales growth
- Group's size expanding to at least EUR500m in EBITDAR by 2016
- Ability to maintain the group's EBITDAR margin of at least 9.5%-10%.
- FFO-adjusted net leverage below 3x (or the equivalent of lease adjusted net debt/EBITDAR to below 2.5x) on a sustained basis
- FFO fixed charge coverage above 3x on as sustained basis
Negative: Future developments that could lead to a negative rating action including but not limited to the Outlook being revised to Stable, include:
- A sharp contraction relative to close peers in like-for-like sales growth
- EBITDAR margin erosion to below 9%
- FFO-adjusted net leverage remaining above 4x (or the equivalent of lease adjusted net debt/EBITDAR to above 3.5x) on a sustained basis
