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Fitch Revises Thomas Cook Outlook to Positive; Rating Affirmed
February 24, 2017 / 1:12 PM / 6 months ago

Fitch Revises Thomas Cook Outlook to Positive; Rating Affirmed

(The following statement was released by the rating agency) LONDON, February 24 (Fitch) Fitch Ratings has revised Thomas Cook Group Plc's (TCG) Outlook to Positive from Stable. The Long-Term Issuer Default Rating (IDR) is affirmed at 'B'. Fitch has also affirmed the senior unsecured rating at 'B+'/'RR3' for the notes issued by TCG and Thomas Cook Finance plc. The positive outlook reflects TCG's improving business profile, which over the years has demonstrated increasing resilience to external events. Continuing restructuring efforts are also helping to boost long-term operating margins and strengthen the business model, resulting in enhanced financial trends. An upgrade of the rating within the next 12 months is likely if the group continues to perform in line with our conservative expectations, which includes turning around the German airlines division or improving group profitability including maintaining positive post-dividend free cash flow on a sustained basis. Sustained gross debt redemptions will be positive for the credit profile, both in terms of allowing greater financial flexibility given the sector profile, but also in terms of potentially enhanced recovery prospects for senior noteholders. KEY RATING DRIVERS Improving Business Profile: Fitch expects TCG to meet our positive rating sensitivity guidance for EBIT margins within a two-year horizon, with EBIT margins expected to improve to pre-2008 levels of 4.5% by the financial year to 30 September 2019 (FY19) on a sustained basis. Over the past five years, management has strengthened its business profile, cut costs, improved its product offering, diversified its customer base and enhanced competitiveness. The group is also expanding geographically under its partnership with Fosun into China, which despite being in start-up phase, is viewed positively leading to our view of an increasingly robust business model. Increasing Resilience: TCG benefits from a strong and trusted brand and is the world's second-largest tour operator. While its ratings reflect the high risk inherent in the tour operator sector, the group consistently demonstrates its flexibility in coping with external shocks. For example, it safely repatriates or moves passengers to alternative destinations thereby partially mitigating the financial impact on the group. In 2016, TCG was able to directly offset 57% of the negative impact on its revenue from the events in Turkey, Egypt and Tunisia. Condor Remains Challenging: We expect the airlines division to remain challenging particularly Condor. Management are implementing an action plan to turnaround its Condor division, targeting GBP35m of annualised profit improvement by FY18. In our view, such target will be challenging to achieve given the heavy competition in the local German market therefore we only factor in a modest profit contribution in our conservative Fitch forecast from FY18 onwards. However, we acknowledge the other airlines operated by the group are performing reasonably well as they benefit from a much larger proportion of seats loaded by TCG's tour operator business. Exposure to External Risks: The tour operator business is vulnerable to a high level of risks and events, most notably geopolitical events, macro-economic pressure and changing weather patterns. We expect TCG to continue to develop its flexibility in responding to such developments, which together with increased diversification of source markets and destinations, should help mitigate their impact and further support our view on the groups increasing resilience, which underpins our positive outlook. Steady Cash Flow Generation: We expect funds from operation (FFO) as a percent of revenue to improve to 4.9% by FY19, having recovered significantly as the heavy costs of restructuring have abated. Going forward, management are introducing a modest dividend linked to performance. However, we expect FCF margin to remain steady at about 2% of revenues through to FY19 having remained positive averaging just over 1% between 2013 and 2016. Such FCF capability is above rating peers in the 'B' rating category. High Seasonality: Working capital is highly seasonal and typically increases in the first quarter of the company's financial year (between October and December) when TCG pays its hotels and other suppliers. Cash balances typically build up in the third and fourth quarters and are paid out in the first quarter of the following financial year. For liquidity calculation we set aside GBP1bn from year-end cash balances as restricted amount, as this is deemed not freely available for debt service throughout the year. We expect TCG to continue to have minimum liquidity headroom of at least GBP200m, which is consistent with the current ratings. Commitment to Delever: Fitch forecasts lease-adjusted funds from operations (FFO) gross leverage will trend towards 4.6x by FYE19 (5.7x at FYE16), which, if materialised, will be more in line with a 'B+' IDR for the sector. In calculating Fitch-adjusted gross leverage, we factor in an amount for gross debt over the financial year, which conservatively takes into account expected average drawings under the revolving credit facility of up to GBP200m in the first quarter of each financial year. In addition, we also exclude GBP542m related to cash pooling, for which an equal amount of cash balances were held at FY16. The positive outlook also reflects the improved financial flexibility derived from management's intention to reduce fixed-term debt by GBP300m by FY18. DERIVATION SUMMARY TCG is the second-largest tour operator in the world, behind TUI AG based on revenues. It is less geographically diverse than TUI, with group EBITDA margin of 6.6% behind TUI's 7.9%, due to TUI having a more diverse product base including cruise ships. TCG's FFO adjusted gross leverage is also about 1.0x higher than TUI, which has reduced gross debt from asset sales in recent years. No country ceiling, parent/subsidiary or operating environment aspects have an impact on the ratings. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Low single digit like-for-like revenue growth - EBIT margin of about 3.8% in FY17, improving towards 4.5% in FY19 - Capex between 2.0% and 2.5% of sales - Dividend payments commencing from FY17 onwards - FCF margin increasing to 1.7% in FY17 but falling back slightly after resumption of dividends - Early repayment of the 2021 senior notes, part funded by additional drawings on the RCF, resulting in lower interest payments in future years RATING SENSITIVITIES Positive: Future Developments That May, Individually or Collectively, Lead to Positive Rating Action Include: - Improved competitiveness evidenced by increasing revenue and recovered EBIT margin within its divisions, leading to group EBIT margin above 4% on a sustained basis; - FFO Fixed charge cover of more than 2.0x (FY16: 1.6x) and FFO-adjusted gross leverage (based on Fitch-adjusted calculation of average gross debt and excluding cash pooling balances) sustainably below 5.0x, driven by a combination of improved profitability and overall gross debt reduction; - Positive post-dividend FCF on a sustained basis. Negative: Future Developments That May, Individually or Collectively, Lead to the Outlook Reverting Back to Stable Include: - Deterioration in the group EBIT margin to below 3.5%, reflecting increased competitive pressures; - Weakening financial flexibility measured as FFO fixed charge cover staying below 1.8x, broadly neutral FCF and/or liquidity headroom below GBP250m; - Increase in FFO-adjusted gross leverage (as adjusted by Fitch) above 5.0x. LIQUIDITY Adequate Liquidity: At FYE16, TCG had adequate liquidity comprising GBP212m of readily available cash (Fitch views GBP1bn as restricted for seasonal working capital purposes and also cash pooling balances) and GBP481m undrawn under its revolving credit facility, comfortably above the minimum threshold of GBP200m that Fitch expects TCG to maintain at any given time. The next material debt maturity is the GBP800m credit facility due 2019, for which we expect refinance risk to be manageable. Management has stated its intention to reduce fixed-term debt by GBP300m by FY18, of which GBP100m has been repaid so far, ultimately improving the group's debt maturity profile as well as reducing interest expense. Contact: Principal Analyst Patrick Durcan Analyst +44 20 3530 1298 Supervisory Analyst Paula Murphy Director +44 20 3530 1718 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chairperson Pablo Mazzini Senior Director +44 20 3530 1021 Summary of Financial Statement Adjustments Debt - Fitch has adjusted the debt by adding 8x of annual operating lease expenses related to long-term asset of estimated GBP273m at FYE16 to arrive at a debt-equivalent figure in our leverage calculation. Debt - Fitch has adjusted debt by adding GBP200m as expected drawings under the revolving credit facility to finance working capital. Debt - Fitch has adjusted debt by deducting GBP542m from debt in respect of cash pooling debit balances that are fully covered by cash pooling credit balances. In turn, we reduce reported cash & cash equivalents balances by GBP542m. Cash - Fitch has lowered reported year-end cash by an amount of GBP1bn which is considered as restricted for working capital purposes and thus not readily available for debt service. Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@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. 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