MARC AFFIRMS ITS RATINGS ON TESCO STORES (MALAYSIA) SDN BHD’S RM3.5 BILLION DEBT PROGRAMME; OUTLOOK REVISED TO NEGATIVE

Feb 20, 2013 -
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 outlook for the ratings is revised to negative from stable. The ratings reflect the credit strength of the corporate guarantee provided by Tesco Malaysia’s parent company, UK-based Tesco PLC (Tesco), for the rated facilities. Tesco carries a public information rating of AAA from MARC based on the retailer’s strong global market position in grocery retailing, its longstanding operational track record and its geographical diversity. The revised outlook to negative is premised on the increasing competitive pressures in Tesco’s primary UK market from which it derives a significant portion of its revenue and earnings, the challenging UK retail market, and increasing group debt levels.
MARC observes that Tesco Malaysia, a joint-venture between Tesco (70%) and Malaysian conglomerate Sime Darby Berhad (30%), has slowed its store expansion in 2012 following a brisk expansion programme since it commenced retailing operations in 2002. For 2012, Tesco Malaysia added only two stores (2011: seven stores) which added about 0.27 million sq ft of retailing space, bringing its total store strength to 47 with 9.67 million sq ft of retailing space. The slower expansion could be attributable to more stringent regulatory environment for opening of new hypermarkets in Malaysia. Nonetheless, among major retailers in Malaysia, Tesco Malaysia retains a leading market position, with a current market share of about 11% in the highly competitive and fragmented domestic grocery retailing segment, characterised mainly by a low pricing strategy. MARC views the retailer’s competitive strengths to be its strong brand recognition, its wide range of product offerings and its store locations in major urban and suburban areas.
Meanwhile, MARC notes that parent Tesco is scaling back on some of its global retailing operations, and at the same time increasing its investments in the UK. In this respect, Tesco has sold a 50% stake in its 117-store Japanese chain and is reviewing its 200-store US-based Fresh and Easy chain, both of which have continued to incur significant losses for the group over the years. Tesco’s UK operations, where it dominates the grocery retailing market with a 30% market share, have come under increasing competitive pressure in recent years and as such, the retailer is undertaking a partly debt-funded £1 billion (RM4.9 billion) investment programme to revamp its UK operations. However, group net debt reduced to £7.2 billion (RM35.6 billion) in the first half of financial year ending February 25, 2013 (1HFY2013) (1HFY2012: £9.5 billion). For 1HFY2013, Tesco’s consolidated revenue grew by a marginal 1.57% to £32.3 billion (1HFY2012: £31.8 billion) while pre-tax profit declined by 11.64% to £1.7 billion (1HFY2012: £1.9 billion) due mainly to rising cost of sales and financing costs. Nevertheless, MARC notes that the group’s liquidity position remains adequate to meet its current financial obligations.
The performance of the group’s Malaysian subsidiary was strong in FY2012, registering a 120.77% increase in pre-tax profit to RM132.9 million (FY2011: RM60.2 million) on the back of a 12.16% growth in revenue to RM4.3 billion (FY2011: RM3.9 billion). The performance was supported by slower growth in operating costs due to the improved scale of operations as well as higher other operating income of RM196.4 million (FY2011: RM163.7 million), which includes increased rental receipts from external parties renting floor space at its larger stores. Tesco Malaysia’s cash flow from operations (CFO) rose sharply to RM509.9 million (FY2011: RM179.7 million) while free cash flow (FCF) turned positive to RM213.4 million on lower capital expenditure due to relatively few store openings in the year.
MARC observes Tesco Malaysia’s total borrowings, including intercompany advances, remained fairly static at about RM2.83 billion as at end-FY2012 (FY2011: RM2.85 billion) despite the RM340.0 million repayment on the IMTN in the year. This is because the repayments are met by a corresponding increase in inter-company loans which continue to be the main source of its IMTN repayments. Notwithstanding this, the debt-to-equity ratio (DE) improved to 13.57 times at end-FY2012 (FY2011: 20.48 times) as shareholders’ funds rose to RM208.8 million on improved earnings. Tesco Malaysia currently has a total of RM175.0 million outstanding MTNs with maturities amounting to RM65.0 million and RM110.0 million in June 2013 and September 2014 respectively, repayments of which are expected to be largely supported by the Tesco group.
The negative outlook reflects the risk of the Tesco’s ratings being lowered if the group’s business and financial profile continue to deteriorate. The rating agency will revise the rating outlook to stable should Tesco be able to strengthen its credit metrics that are commensurate with the current rating band.
Contacts:
Taufiq Kamal, +603-2082 2251/ taufiq@marc.com.my;
Ngiam Tee Wei, +03-2082 2268/ teewei@marc.com.my;
Rajan Paramesran, +603-2082 2233/ rajan@marc.com.my.