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Fitch Rates Thomas Cook's Planned Senior Unsecured Notes 'BB-(EXP)'
November 28, 2017 / 5:06 PM / 20 days ago

Fitch Rates Thomas Cook's Planned Senior Unsecured Notes 'BB-(EXP)'

(The following statement was released by the rating agency) LONDON, November 28 (Fitch) Fitch Ratings has assigned Thomas Cook Finance 2 Ltd's planned EUR400 million senior unsecured notes due 2023 an expected senior unsecured rating of 'BB-(EXP)'/'RR3'. The final rating is contingent upon the receipt of final documents conforming to information already received by Fitch. Proceeds are likely to be used for the early redemption of Thomas Cook Group's (TCG; B+/Stable Outlook) notes due in 2021. The planned notes will be unsecured, ranking pari-passu to all existing and future unsecured indebtedness of the issuer that is not subordinated to the notes. The new bonds will be guaranteed by subsidiaries representing 97% of group EBITDAR and 94% of total assets (excluding goodwill) respectively. We expect slightly above-average recovery prospects for unsecured bond holders in the event of default, resulting in a 'BB-(EXP)' rating for the planned bond. KEY RATING DRIVERS More Robust Business Model: Fitch expects TCG to improve its EBIT margin towards 4% on a sustained basis by the financial year ending September 2018 (FY18), reaching 4.5% by FY20. This is due to improved profits in continental Europe and a turnaround at Condor in FY17 as well as some benefits from the New Operating Model (NUMO), mitigating some weakening in the UK operations. Such profit margin would be comparable to pre-2008 levels (4.2%), despite competition from other tour operators (some online). The improvement is due to continuing efforts by TCG to strengthen its business profile, cut costs, improve its product offering and diversify its customer base, resulting in enhanced competitiveness. The group is also expanding geographically under its partnership with Fosun into China. Increasing Resilience: TCG benefits from a strong and trusted brand and is the world's second-largest tour operator. The ratings reflect the high risk inherent in the tour operator sector, but the group has consistently demonstrated its flexibility in coping with external shocks and strong competition. Brexit Uncertainty Mitigated by Diversification: TCG has also demonstrated revenue resilience since the UK's vote to leave the EU, with bookings continuing to grow. Some uncertainties regarding future demand remain, but reported like-for-like (LfL) sales continued to increase by 6.5% in the UK during FY17. However, this growth was negatively impacted by higher costs, resulting in a large drop in UK gross margins, and EBIT in the UK business falling by GBP33 million in FY17. TCG's diversity of end-destinations has been a differentiating factor, with some customers now buying more "value" options, as seen with a return to growth for Turkey and Egypt. It has increased its diversification of source markets while the UK business contributes now only about one third to the group's total operating profit. Given that TCG does not hedge profits in euros and Swedish krona, the group's profit can benefit from the depreciation of the pound given roughly two-thirds of revenue is earned elsewhere. Condor Turnaround Materialising: Management announced an action plan at the end of FY16 to turn around the German airlines business, and its benefits started to be seen in in the second half of FY17, showing a GBP24 million improvement in underlying EBIT on the previous year. The group has benefited from the difficult operating environment for other airlines in Germany, reducing capacity in this market. However, we remain cautious on the future profitability of this division, and continue to forecast EBIT to remain below historical levels over the next three years In addition, 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. Overall in FY17 the group's airline EBIT improved by GBP34 million, mainly driven by the Condor turnaround. Exposure to External Risks: As a tour operator, TCG's business remains vulnerable to a high level of risks and events, most notably geopolitical events, macroeconomic pressure and changing weather patterns. These underlying risks are reflected in the 'B' category rating. We expect TCG to continue to increase its flexibility to respond to such developments, which together with increased diversification of source markets and destinations, should help mitigate their impact, underlining the improvement in the business risk profile. Steady Cash-Flow Generation: We expect funds from operations (FFO) as a percentage of revenue to improve to 4.6% by FY19, recovering after past one-off and other costs associated with the NUMO programme as well as lower interest costs due to ongoing balance sheet management. Management is introducing a modest dividend policy linked to earnings performance. However, we expect its free cash flow (FCF) margin to remain positive, growing towards 2% of revenue over the next three years, having averaged just over 1% between 2013 and 2016. TCG's FCF capability is above the 'B' rating median for peers and strong relative to airline peers'. 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 after the busy summer season. Given the September year-end, cash balances typically build up during the third and fourth quarters and are paid out in the first quarter of the following financial year. Commitment to Deleveraging: Fitch forecasts that FFO adjusted gross leverage will fall below 5.0x in FY19 (from 5.5x at FYE17). In addition, TCG's deleveraging capacity benefits from the group's strong FCF-generating ability and management's focus on maintaining a more conservative balance sheet policy. DERIVATION SUMMARY TCG is the second-largest tour operator in the world, behind TUI AG based on revenue. It is less geographically diverse than TUI, with group EBITDA margin (6.1% in FY17) below TUI's (7.9% in FY16), due to TUI having a more diverse product base including cruise ships. TCG's FFO-adjusted gross leverage is also slightly higher than TUI's. TCG's operating margin is lower than Expedia Inc's (BBB-/Stable) or hotel operators'. Moreover, TCG's business risk is higher than an internet or a hotel operator's due to the necessity to efficiently manage its cost base (fuel costs, FX because of its own fleet of aircraft) and seasonality during the year. However, TCG's business risk is much lower than airline companies' due to a flexible model (more asset-light than an airline company, flexibility in reducing capacity, re-routing customers and a multi-channel operator). KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Low single digit like-for-like growth from FY18 onwards; - EBIT margin improving towards 4.5% in FY20; - Capex about GBP200 million per annum; - Cash outflows from dividends continuing annually, targeting roughly 30% of profits after tax; and - FCF margin improving towards 2% by 2020. Recovery Assumptions: - Our recovery analysis assumes that TCG would be treated as a going concern in a restructuring and that the company would be reorganised rather than liquidated. We have assumed a 10% administrative claim. - TCG's going-concern EBITDA is based on 2017 EBITDA of EUR552 million. Given the going concern assumption, we deduct the present value of finance leases payable at FYE17 of GBP39 million as well as interest payable of GBP16 million. - After these deductions and implying a stressed discount, we arrive at an estimated post-restructuring EBITDA available to creditors of EUR326 million. - We then apply a conservative distressed enterprise value (EV)/EBITDA multiple of 4.5x, resulting in an EV of GBP1,467 million. - In terms of distribution of value, unsecured debtholders (including bonds and pension obligations) would recover 59% in the event of default consistent with a Recovery Rating 'RR3' and an instrument rating of 'BB-', one notch above TCG's IDR. In this analysis, we assume that the full amount under the group's revolving credit facility (RCF) will be fully drawn. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action -Continued improvements in the business model, and profit resilience resulting in EBIT margin remaining above 5% on a sustained basis, and continuing positive FCF margin. -Maintenance of conservative capital allocation policy reflected in FFO lease-adjusted gross leverage (including additional GBP200 million RCF drawing) falling consistently below 4.0x (FY17: 5.5x). -A reduction in overall interest expenses and enhanced profitability leading to FFO fixed charge coverage rising to above 2.5x (FY17: 1.6x) on a sustained basis. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action -Competitive pressures or deterioration in airline profitability resulting in EBIT margins remaining continually below 4%. -FFO-adjusted gross leverage remaining above 5.0x on a sustained basis. - Weakening financial flexibility measured as FFO fixed charge cover staying below 2.0x on a sustained basis or liquidity headroom below GBP250 million. LIQUIDITY Adequate Liquidity: At FYE17, TCG had sufficient liquidity, comprising GBP374 million of readily available cash (Fitch views GBP1 billion as restricted for seasonal working-capital purposes, and also excludes GBP28 million for cash held in escrow accounts and at the group's captive insurance companies). At the time of issuance, we expect TCG will have roughly GBP485 million available undrawn under its RCF, comfortably above the minimum threshold of GBP250 million that Fitch expects TCG to maintain at any given time. Following the redemption of the 2021 notes, the next material debt maturity is the EUR750 million notes due in 2022, and we expect refinancing risk to be manageable. Contact: Principal Analyst Patrick Durcan Analyst +44 20 3530 1298 Supervisory Analyst Jean-Pierre Husband Director +44 20 3530 1155 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chairperson Sophie Coutaux Senior Director +33 1 44 29 91 32 Date of Relevant Rating Committee: 23 August 2017 Media Relations: Adrian Simpson, London, Tel: +44 203 530 1010, Email: adrian.simpson@fitchratings.com. Summary of Financial Statement Adjustments - Debt - Fitch has adjusted the debt by adding 8x annual operating lease expenses related to long-term assets of estimated GBP311 million at FYE17 to arrive at a debt-equivalent figure in our leverage calculation. Debt - Fitch has adjusted debt by adding GBP200 million as expected average drawings under the RCF to finance working capital. Cash - Fitch has lowered reported year-end cash by GBP1 billion, which is considered as restricted for working-capital purposes and thus not readily available for debt service. We also exclude GBP28 million for cash held in escrow accounts and at the group's captive insurance companies. 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 Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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