MARC is issuing this rating update in connection with its MARC-1(cg)/AAA(cg) and MARC-1ID(cg)/AAAID(cg) ratings on Tesco Stores (Malaysia) Sdn Bhd’s (Tesco Malaysia) RM3.5 billion Conventional and Islamic Commercial Paper and Medium Term Notes (CP/MTN) Programme. Tesco Malaysia has issued RM700 million under the CP/MTN Programme as of todate. The ratings on Tesco Malaysia’s issuances are underpinned by guarantees extended by Tesco PLC (Tesco). Since MARC’s rating outlook revision to negative on 2 June 2008 on Tesco, the Group has announced its buyout of Royal Bank of Scotland’s (RBS) 50% share of their personal finance joint venture, Tesco Personal Finance (TPF) for £950 million. Tesco has also embarked on initiatives to prevent further weakening of its credit metrics.

Tesco is the largest food retailer in the United Kingdom with an estimated 20% grocery market share and ranks among the top three grocery retailers in the world. In recent years, Tesco has become increasingly reliant on growth from outside the UK. In May 2008, it became the second largest supermarket chain in South Korea, following a £958 million acquisition of 36 discount stores in the country. It recently announced that it will open wholesale stores in India in a tie-up with Trent, the retail arm of the Tata Group, with an initial investment of up to £60 million.

By the end of FY2008, the Group had a total of 3,729 stores worldwide and a capital spending bill of £3.9 billion in the same year, up from the £3.0 billion reported in FY2007. For the financial year ending 23 February 2008 (FY2008), the Group recorded revenue of £47.3 billion and an operating profit of £2.8 billion, which represent year-on-year increases of 10.9% and 5.4%, respectively. International sales grew by 24.5% in FY2008. MARC believes that Tesco’s operating environment will likely become more challenging in the near-term particularly for its UK and United States based operations due to rising economic pressures on consumers in these markets.

In July, Tesco acquired 50% of TPF for a cash consideration of £950 million from Royal Bank of Scotland (RBS), which would be financed by debt. TPF offers credit cards and general insurance in-store and online. This division generated £206 million profit before tax in 2007. While Tesco’s recent acquisitions will contribute to improve earnings diversity by geography and business line, the debt financing used will put additional pressure on its existing total borrowings, which stood at £8.1 billion at the end of FY2008. The TPF stake is expected to be earnings accretive from the year of acquisition.

Tesco is expected to reduce its original £4.2 billion capital expenditure by £1 billion. The Group’s plans to restore its credit metrics include monetising its real estate assets and exercising more constraint over its capital expenditures on store refurbishment and site developments while still meeting its target of adding 863 stores in FY2009. Tesco is also enhancing working capital management to improve its cash flow from operations. Tesco is expected to have a net borrowing of £7.5 billion to £8 billion after implementation of these measures.

The ratings are supported by Tesco’s strong operating performance and leadership position in the UK market and international diversification. The ratings also acknowledge Tesco’s efforts and commitment to debt reduction, as well as its apparent focus on improving working capital.

Tesco Malaysia, a 70% owned subsidiary of Tesco, is a leading domestic hypermarket operator with 23 stores in Malaysia. Tesco Malaysia is in the midst of finalising its accounts for financial year ended February 2008 (FY2008), after posting its first operating profit since inception of RM17.9 million in FY2007.

MARC will continue to monitor the impact of Tesco’s acquisition-growth strategy and measures taken by the Group to mitigate potential prospective deterioration in credit protection measures. MARC will reconsider its ratings outlook if Tesco’s financial profile does not stabilise in the next several months.

Contacts:

Khairul Muzamel Perera 03-2090 2247/ kevinkhairul@marc.com.my;
Francis Xaviour Joe, 03-2090 2279/ fxjoe@marc.com.my.