MARC AFFIRMS ITS RATINGS ON TESCO STORES (MALAYSIA) SDN BHD'S RM3.5 BILLION DEBT PROGRAMME

MARC has affirmed Tesco Stores (Malaysia) Sdn Bhd's (Tesco Malaysia) RM3.5 billion Conventional Commercial Papers/Medium Term Notes (CP/MTN) Facility and Islamic Commercial Papers/Medium Term Notes (ICP/IMTN) Facility at MARC-1(cg)/AAA(cg) and MARC-1ID(cg)/AAAID(cg) respectively. The ratings carry a stable outlook. The affirmed ratings and outlook are premised on the corporate guarantee provided by Tesco Malaysia's parent company, Tesco plc (Tesco) for the rated facilities. Tesco carries a public information rating of AAA/stable from MARC based on the retailer's strong business and financial profile. The retailer's earnings profile continues to be characterised by fairly steady operating margins, a good measure of resilience to economic cycles and improving geographic diversification in terms of earnings.

MARC notes that in tandem with its parent Tesco's business strategy, Tesco Malaysia continues to expand its retail network, increasing its number of stores to currently 45 as at end of December 2011 (FY2012) from 38 stores in 2010 (FY2011). Correspondingly, total retailing space rose to 3.6 million sq ft from 3.3 million sq ft in FY2012. The rapid expansion of retail space has enabled Tesco Malaysia to benefit from scale economies and maintain its leading market position in the domestic grocery retailing industry with 9.6% share as of July, 2011 (June 2011: 9.3%). MARC believes that Tesco Malaysia's near- to medium-term business emphasises cost efficiency, the closure of underperforming stores and new store openings to benefit from increasing returns to scale. Nonetheless, MARC notes that the rapid expansion of its store network continues to be funded by high debt levels, resulting in further weakening in the company's credit metrics.

For financial year ending February 28, 2011 (FY2011), Tesco Malaysia registered a 21.5% decline in pre-tax profit to RM60.2 million from RM76.7 million in FY2010, despite a 9.3% and 13.5% year-on-year increase in revenue and operating profit, due mainly to a significant rise in financial charges. In FY2011, borrowings rose by RM800 million, of which RM640 million was obtained from Tesco Stores Limited, Tesco's principal trading subsidiary, to meet the repayment of RM400.0 million under its MTN facility due this year. With that redemption, Tesco Malaysia currently has a total of RM585.0 million outstanding MTNs with maturities amounting to RM410.0 million, RM65.0 million and RM110.0 million in 2012, 2013 and 2014 respectively. Its debt-to-equity ratio (DE) for FY2011 remains elevated at 20.5 times (FY2010: 25.5 times), moderated only by a greater percentage increase in shareholders' equity compared to total debt. Despite Tesco Malaysia's positive cash flow from operations (CFO), its free cash flow remains negative which would imply Tesco Malaysia's continued reliance on parent or related-company funding to meet its forthcoming maturities.

For parent Tesco, key profitability measures as assessed by MARC, improved in FY2011. Tesco's consolidated revenue rose by 7.1% to £60.9 billion in FY2011, on the back of strong contributions from UK and South Korean operations which registered increases of 4.0% and 19.3% to £40.1 billion and £5.0 billion respectively. CFO, however, recorded a decrease of £0.8 billion in FY2011 compared to FY2010 on the back of higher inventory levels at year end. MARC notes that the group's gearing level as measured by its DE ratio continue to improve since FY2009, falling to 0.67 times as at end-FY2011 on the back of annual net debt repayment of £2.0 billion. Going forward, while the strong operating performance of its Asian operations has somewhat compensated for the weaker retail environment in much of Europe and the US, Tesco group is likely to face challenges in sustaining its growth momentum into FY2012/13. The group continues to record losses in the US due to a combination of heavy capital investment in distribution channels and insufficient scale of operations. Nonetheless, Tesco expects the US operations to breakeven in FY2012/13 with additional store openings. The rating agency expects Tesco's financial metrics to remain broadly stable, based on recent trends in its gearing level and sustained cash flow coverage measures, although the rating agency's analysis of the holding company's contingent liabilities - with respect to parent-guaranteed subsidiary debt - is constrained by its modest financial statement disclosures of the same.

The stable rating outlook also reflects MARC's expectation that support would be forthcoming from Tesco in respect of Tesco Malaysia's forthcoming note maturities as witnessed earlier for the subsidiary's FY2011 note maturities.

Contacts: Rajan Paramesran, +603-2082 2233/ rajan@marc.com.my; Ahmad Gazzara Czillich, +603-2082 2259/ gazzara@marc.com.my.