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Fitch: Tesco Rating Captures Profit Warning; Benefits from Cash Flow Preservation
September 1, 2014 / 2:40 PM / 3 years ago

Fitch: Tesco Rating Captures Profit Warning; Benefits from Cash Flow Preservation

(The following statement was released by the rating agency) LONDON/MILAN, September 01 (Fitch) Fitch Rating says Tesco PLC's (BBB/Stable) recent trading update highlights increasing business risk at the UK's leading food retailer as it remains exposed to continued structural evolution of demand and accelerating price competition. These factors are reflected in Tesco's ratings, which were downgraded in June 2014, and mitigated in the short-term by the group's announced cuts in dividend and capex. The announcement confirmed the materialisation of two key drivers behind the recent rating downgrade: the group's increased difficulties in effectively responding to growing domestic competitive pressures and rising uncertainty around its strategic repositioning. The trading statement highlights that in Tesco's domestic operations trading performance, market share, and profitability remained under pressure over the summer period, leading to a sharper erosion of EBIT margin than Fitch's projections in June, as the group guides towards a full-year profit of GBP2.4bn-2.5bn (a drop of up to GBP0.6bn). Tesco, as the largest UK food retailer with a focus on large formats and hypermarkets, is particularly susceptible to the accelerating price competition across the industry, given the impact of significant operational leverage on its profitability. In addition, uncertainty is growing around the execution of the group's domestic repositioning and strategy implementation with the arrival of new senior management and a reduced capex budget of GBP2.1bn (down by GBP400m), effectively delaying the initiated store refresh programme in the UK ahead of the new senior management arrival. In its June commentary Fitch had highlighted risks over capital allocation given competing investment needs across the group and execution risk over successful strategy implementation as impediments to an operational turnaround. Fitch, however, notes that against such increasing business risk, the Board have announced capital preservation measures by cutting investments and dividends, alleviating immediate pressures on the group's financial profile. As a result, the agency expects Tesco's overall risk profile to remain consistent with the 'BBB' rating, based on the sensitivities formulated by Fitch for a potential negative rating action (summarised at the end of this comment). The rating also encapsulates Tesco's market leading size and operational scale, including international diversification and presence in all key food retailing channels, which Fitch believes will give the group strategic options to develop its business model and brand in the face of the changing competitive environment. However, a continued erosion of market share and profitability, illustrating an unsuccessful strategic repositioning and leading to a sustained weakening of the financial profile, could trigger negative rating action in the medium term. Future developments that could lead to a negative rating action include: -Group EBIT margin deteriorating to below 4% on a sustained basis, with accelerating competitive pressures in the UK food retail market and continuing headwinds in the international operations -Continued loss of market share in its domestic operations -Funds from operations (FFO) fixed charge cover below 2.5x on a sustained basis -Retail-only (excluding Tesco bank) FFO adjusted net leverage above 4.0x -Sustained negative FCF margin (post capex & dividends) resulting in an upward trend in leverage Contact: Frank Orthbandt Director +44 20 3530 1037 Fitch Ratings Limited 30 North Colonnade London E14 5GN Roma Patel Analyst +44 20 3530 1465 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email:; Athos Larkou, London, Tel: +44 203 530 1549, Email: Additional information is available on ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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