TESCO STORES (MALAYSIA) SDN BHD - 2015

MARC has downgraded the long-term ratings on Tesco Stores (Malaysia) Sdn Bhd’s (Tesco Malaysia) RM3.5 billion Conventional and Islamic Medium-Term Notes Programmes to AA-_(cg) and AA-_ID(cg) from AA_(cg) and AA_ID(cg) respectively. Concurrently, the short-term rating on the Conventional Commercial Papers Programme has been maintained at MARC-1_(cg). The outlook on all ratings remains negative.

The long-term ratings downgrade reflects MARC’s assessment of UK-based Tesco PLC (Tesco) which has provided corporate guarantees on the rated programmes. The rating agency has lowered its public information long-term rating on Tesco to AA-/negative from AA/negative due to the retailer’s weakened business and financial profiles. MARC views that the challenging conditions in the UK retail market would continue to weigh on the group’s operating performance; any significant turnaround in Tesco’s competitive position may only materialise over the longer term.

For the unaudited first half of financial year ending February 28, 2016 (1HFY2016), Tesco reported lower revenue of £27.2 billion (1HFY2015: £27.9 billion). Tesco’s market share in UK declined to 28.2% for the 12 weeks to September 13, 2015 from 28.8% during the same period in 2014 according to market researcher Kantar Worldpanel. The gross profit margin fell to 4.7% from 5.8%, reflecting the challenges the retailer faces in building a customer-centric strategy and improving price competitiveness.

For 1HFY2016, operating profit improved to £354.0 million; however, Tesco reported a net loss of £368.0 million, mainly as a result of a deferred tax change in its discontinued operations. Tesco’s shareholders’ equity declined to £6.2 billion as at end-1HFY2016 from £7.1 billion in FY2015 and consequently debt-to-equity (DE) rose to 2.0x in 1HFY2016 from 1.8x in FY2015. Tesco is implementing measures to strengthen its operations and balance sheet. These include the disposal of its Korean business that will reduce total indebtedness by £4.2 billion and the sale of UK properties for £250.0 million recently. The proceeds will reduce Tesco’s pro-forma obligations comprising net debt, operating lease commitments and pension deficit of £21.9 billion as at end-1HFY2016 to £17.4 billion.

Other measures include limiting net capex to £1.0 billion for FY2016, which has contributed to positive free cash flow (FCF) of £236.0 million in 1HFY2016 (FY2015: negative £1.6 billion). Tesco has also closed 53 stores in the UK since the beginning of 2015 to support its efforts to preserve liquidity. MARC views Tesco’s financial flexibility as strong with undrawn committed multi-year credit facilities and cash and cash equivalents of £5.0 billion and £2.2 billion respectively as at end-FY2015.

Tesco’s 70%-held Tesco Malaysia registered weaker revenue of RM4,518.0 million and pre-tax loss of RM312.0 million for FY2015 (FY2014: RM4,657.9 million; pre-tax profit: RM131.8 million). The loss was contributed by a write-off of RM198.3 million on impairment loss on property, plant and equipment, and RM118.3 million for allowance for slow-moving inventory due to a change in provisioning policy. CFO declined sharply to RM137.3 million in FY2015 (FY2014: RM412.5 million) while FCF was negative RM167.0 million (FY2014: positive RM130.9 million) which was largely funded by intercompany borrowings within the Tesco group.

In respect of its ability to meet its financial obligations, Tesco Malaysia may have to rely on funding from the unutilised rated programmes and/or on support from its parent company through inter-company loans as has been the case in the past. MARC regards Tesco Malaysia’s financial flexibility to be adequate.

The negative outlook reflects MARC’s view that Tesco faces more downside risks over the near term as it undertakes measures to strengthen its balance sheet and restore profitability. The rating would be lowered if there is no discernible improvement in Tesco’s credit metrics and/or if its market share continues to slide. The ratings could be maintained if Tesco establishes sustained improvement in its profitability and competitiveness in terms of market share leading to an improvement in credit metrics.

Major Rating Factors

Strengths

• Major player in the domestic grocery retail market; and
• Part of Tesco group, one of the world’s largest retailer.

Challenges/Risks

• Weakening operating and financial profile of financial guarantor, Tesco PLC; and
• Increasing competitive pressures within the UK retail sector.