MARC LOWERS ITS RATINGS ON TESCO STORES (MALAYSIA) SDN BHD’S RM3.5 BILLION CP/MTN AND ICP/IMTN DEBT PROGRAMME TO MARC-1(cg) /AA+(cg) and MARC-1ID(cg) /AA+ID(cg) RESPECTIVELY

Jan 15, 2014 -

MARC has lowered its ratings on 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 to MARC-1(cg) /AA+(cg) and MARC-1ID(cg) /AA+ID(cg) from MARC-1(cg) /AAA(cg) and MARC-1ID(cg) /AAAID(cg) respectively. The outlook for the ratings is revised to stable from negative. 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. MARC has lowered its public information rating on Tesco from AAA/negative to AA+/stable to reflect the retailer’s weakened business and credit profile, arising mainly from increased competitive pressures in its primary UK market and from measures taken to mitigate further potential deterioration in some of the group’s global operations.  

Notwithstanding Tesco’s dominant market share of the UK grocery retailing sector of about 30%, MARC notes that the retailer has continued to experience pressure on trading profit margins which declined to 5.2% for financial year ending February 28, 2013 (FY2013) from 6.1% in FY2009. Tesco continues to derive a significant portion of its revenue and trading profits from its UK market, which accounted for 66.6% and 65.8% of total revenue and trading profits respectively in FY2013, although revenue growth has not kept pace with the increase in sales area. Since 2009, the UK sales area has grown by 26.7% to 41.0 million square feet but revenue per square foot declined from £1,174.1 to £1,080.0 in FY2013. Nonetheless, following the implementation of recent measures that include a £1.0 billion revamp programme, Tesco’s UK operations have seen a slower pace of decline in its profitability measures.  

In respect of Tesco’s non-UK operations, MARC observes that the group, which ranks as the third largest global retailer, has continued to rationalise its global retailing operations. Following the divestment of a majority of its 200-store chain in the US under the Fresh and Easy brand and the sale of a 50% stake in its 117-store chain in Japan, the group plans to inject its 134 stores in China into a joint venture company with China state-controlled retail group China Resources Enterprise (CRE). Tesco will hold a 20% stake in the joint venture, subject to regulatory and CRE shareholder approvals. For FY2013, the group registered losses of £1.3 billion from discontinued operations. MARC views Tesco’s current challenges to stem mainly from the prevailing weak economic environment in some of the 11 countries, outside of the UK in which it operates, although the performance of its Asian operations has somewhat compensated for the weaker European operations. The group’s revenue rose marginally year-on-year to £64.8 billion in FY2013 (FY2012: £63.9 billion), but pre-tax profit declined sharply by 51.5% to £2.0 billion (FY2012: £4.0 billion). This is attributable to weaker trading margins as well as write-downs on its UK properties, goodwill impairment on its European ventures and provisions made for potential claims against Tesco Bank.

Notwithstanding the foregoing, the group’s cash flow generation has remained strong with cash flow from operations (CFO) coverage measures of 7.2 times interest expense (FY2012: 9.3 times) and 0.3 times total borrowings (FY2012: 0.4 times). Tesco’s consolidated cash position stood at £2.5 billion as at end-FY2013 (end-FY2012: £2.3 billion), although this was largely supported by liquidation of short-term investments and disposal of non-current assets. The group’s capital spending of £3.0 billion during FY2013 (4.1% of sales) was lower than management’s earlier expectation of £3.3 billion but is expected to range from 3.5% to 4.0% of sales per annum going forward. Net debt declined by £241.0 million to £6.6 billion in FY2013, translating to net debt to equity of 0.4 times (FY2012: 0.4 times). MARC views the prevailing gearing level as manageable while the undrawn credit facility of £2.8 billion as at end-FY2013 provides strong financial flexibility. For 1HFY2014, consolidated revenue grew by a marginal 1.6% to £32.2 billion from the preceding period last year (1HFY2013: £31.6 billion) while pre-tax profit declined by 23.5% to £1.4 billion (1HFY2013: £1.8 billion) due mainly to rising cost of sales and financing costs. 

MARC observes the standalone credit profile of Tesco Malaysia, in which Tesco has a 70% stake, has come under some pressure from the competition from existing retailers and recent entrants to the Malaysian grocery retailing industry. Tesco Malaysia, which has 49 stores as at end-2013, has expanded its store strength at a slower pace, adding only two stores each in 2012 and 2013 (2010: 6; 2011: 10) due to the stringent regulatory process for opening of hypermarkets. However, Tesco Malaysia remains the domestic market leader with a 10.9% market share as at mid-July 2013, albeit registering a steady decline in recent years (mid-July 2011: 11.7%; mid-July 2012: 11.1%). 

For FY2013, Tesco Malaysia’s revenue grew by 5.6% to RM4,568.0 million in FY2013 (FY2012: RM4,327.7 million) while operating profit declined by 14.2% to RM223.7 million (FY2012: RM260.9 million) mainly on account of higher selling and distribution expenses, and administrative expenses. CFO stood at RM380.6 million in FY2013 (FY2012: RM511.0 million) due to weaker earnings and working capital outflows. The company’s borrowings continue to be characterised by sizeable intercompany loans which accounted for 88.2% of the outstanding RM3,186.8 million borrowings as at end-FY2013 (FY2012: RM3,182.2 million). The intercompany loans are expected to be the source of repayment of Tesco Malaysia’s current outstanding of RM110.0 million MTNs, which are due for redemption on September 2, 2014.   

The stable rating outlook reflects MARC’s expectations that Tesco’s credit metrics will remain commensurate with the current rating. 

Contacts:

Taufiq Kamal, +603-2082 2251/ taufiq@marc.com.my;

Ngiam Tee Wei, +603-2082 2268/ teewei@marc.com.my;

Rajan Paramesran, +603-2083 2233/ rajan@marc.com.my.