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8 months ago
Fitch Affirms Kingfisher at 'BBB'; Outlook Stable
December 15, 2016 / 4:25 PM / 8 months ago

Fitch Affirms Kingfisher at 'BBB'; Outlook Stable

(The following statement was released by the rating agency) LONDON, December 15 (Fitch) Fitch Ratings has affirmed UK-based home improvement retailer Kingfisher Plc's Long-Term Issuer Default Rating (IDR) at 'BBB' with Stable Outlook. The Short-Term IDR and the senior unsecured ratings are also affirmed at 'F2' and 'BBB', respectively. The ratings and Stable Outlook reflect Kingfisher's leading market shares, established brands and geographic diversification. The One Kingfisher plan to increase profit by GBP500m a year carries moderate execution risk in our view and mildly increases net leverage, but management has the ability, based on its track record, to deliver the planned improvements provided trading conditions remain supportive, leading to limited margin sacrifices over the rating horizon. Rating constraints include the macro environment in the UK and France, increasing competitive pressures, exposure to the housing market and changing consumer spending. KEY RATING DRIVERS Steady Operating Performance to Continue Fitch expects Kingfisher to have steady operating performance by financial year ending January 2019 (FY19). In our rating case we expect revenue to grow 1%-2% a year, driven by steady performance in the UK, partially offset by a challenging French market and increasing competition. We view execution risk as moderate due to the company's size and complexity; however, management has the skills to implement most of the cost savings related to procurement benefits and enhanced IT infrastructure. In our rating case we include 70% of management's stated uplift of GBP500m, which is weighted more towards the latter years. We expect EBITDA margins will be weak for the rating (at 8.2%) in FY17. However, cost savings should allow the group EBITDA margin to trend towards 9% in FY19, as the One Kingfisher plan begins to bear fruit. We expect free cash flow (FCF) to be broadly neutral by FY19, dragged down by capex, which we expect will peak at close to 5% of sales in FY18, and the savings plan implementation costs. Screwfix Drives UK Retail Growth We view the Screwfix business model as best in class, which has helped the group through the economic downturn. Consumer spending habits have moved away from "do it yourself" to "do it for me", particularly among millennials in the UK, driving growth at Screwfix. We expect this trend to continue over our rating horizon, although its rate may decline in 2017 and 2018 compared to previous years due to Brexit, which is likely to slow consumer spending as inflation reduces disposable income. Competition for B&Q, particularly from Bunnings and online disruptors, will remain intense. Therefore we estimate that management may need to reinvest part of the margin uplift from its cost savings plan in its pricing or product proposition to remain competitive. France Still Subdued We expect conditions to remain challenging over the rating horizon and for the French division to only return to growth in FY19, although the overall margin should improve due to cost savings at the group level. Poor weather, heavy competition, the uncertain political environment and terrorist attacks have all contributed to the weaker performance in France. However, housing sales reached their highest in the second quarter of 2016 although this may not be sustainable in the medium term. We expect margins to improve due to the One Kingfisher plan as the group benefits from procurement savings and operational efficiencies. International Reinvesting in Expansion We expect profits to be flat to FY19 due to continued momentum in Poland, Russia and Spain being offset by new start-ups. The International division contributed 15% of Kingfisher Retail profit at FYE16, although with mixed results, with the main profit generator Poland. We expect this trend to continue over our rating horizon as the contribution from new country start-ups mitigates any slowdown from more established markets outside France and the UK, holding back growth in the contribution from its International division to group profits. Correlation to Consumer Spending Constraints Rating Kingfisher's business profile remains strongly correlated to underlying consumer spending and linked to activities in the housing and construction markets. In the UK, Fitch expects consumer spending to decline from 2.8% in 2016 to 1.3% in 2017, as the currency depreciation and higher inflation squeeze household real income growth. In France, we expect a decline from 1.4% in 2016 to 0.8% in 2017 as the boost to real disposable income from low energy prices will gradually diminish. Comfortable Leverage We expect Kingfisher to increase its total debt by around GBP350m over the coming years, as most of the EBIT uplift is weighted towards the end of the five-year plan. In addition, Kingfisher has announced it plans to return GBP600m of cash to shareholders over the next three years. Consequently, we expect funds from operations (FFO)-adjusted net leverage to be around 2.9x in FY19 (up from 2.6x in FY16), comfortably within our guidance for the 'BBB' rating. Management has reaffirmed its intention to continue to operate within its stated target of 2.5x net lease-adjusted debt to EBITDAR, which we believe is achievable within our rating case. DERIVATION SUMMARY Kingfisher is the second largest home improvement retailer in Europe and the fourth largest in the world, behind Home Depot (US; A/Stable), Lowes (US) and Adeo (France). It has over 1,100 stores, operating primarily in the UK and France and to a lesser extent internationally. Kingfisher's EBITDAR margin has lagged behind most of its peers', particularly Home Depot, which has been increasing profit margins since 2010, and has the highest margin among publicly rated peers. Kingfisher's prudent financial policy means its leverage is in line with, or lower than, its peers; however we expect leverage to increase mildly temporarily as the group implements its transformation plan. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Group revenue growth of 1%-2% from FY17 to FY19, steady growth in the UK, partially offset by a challenging French market and ever-increasing competition (FY16: -4.8%) - Group EBIT margin to recover to around 6.4% by FY19 from 6% expected in in FY17 (FY16: 6.6%), supported by cumulative EBIT uplift of around 70% of planned GBP500m over five years - GBP220m profit and loss transformation costs and GBP270m of cash transformation costs, in line with management guidance. - GBP310m transformational capex costs over three years - Dividend payout of around 50% of net income - Share buyback of GBP200m a year between FY17 and FY19 - Debt drawn down of GBP100m a year in FY18 and FY19 and GBP150m in FY20 RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action -Structural improvement in profitability, with EBIT margin remaining sustainably above 9% (FY16: 6.6%) and underpinned by strong market share and geographical diversification. -Positive free cash flow (FCF) generation. -Continued conservative financial policy leading to FFO-adjusted net leverage sustainably below 2x (FY16: 2.6x) and FFO fixed charge coverage above 4.0x (FY16: 2.8x). Future Developments That May, Individually or Collectively, Lead to Negative Rating Action -Structural deterioration in profitability leading to EBIT margin below 6.5% and a decline in market share in core markets. -Negative FCF generation and a more aggressive financial policy leading to FFO-adjusted net leverage sustainably above 3.5x and FFO fixed charge coverage below 2.7x. LIQUIDITY Satisfactory Liquidity At 1H17 Kingfisher had a GBP225m undrawn committee facility expiring in 2021, supported by readily available cash of GBP884m (as defined by Fitch and assuming GBP250m of not readily available cash absorbed by working capital swings within the year). This was more than sufficient to cover maturing debt of GBP138m at FY17, with the next major maturity the USD179m private placement due May 2018. Contact: Principal Analyst Maggie Cheng Associate Director +44 20 3530 1689 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 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Summary of Financial Statement Adjustments - Leases - Fitch has adjusted debt by adding 8x of annual operating lease expense related to long-term assets of GBP411m at FY16. Cash - Fitch treats GBP250m of cash as restricted for intra-year working-capital seasonality purposes. Additional information is available on www.fitchratings.com.. 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