MARC has affirmed the ratings of AAA(cg)/MARC-1(cg) and AAAID(cg)/MARC-1ID(cg) on Tesco Stores (Malaysia) Sdn Bhd’s (Tesco Malaysia) RM3.5 billion Conventional and Islamic Commercial Paper and Medium Term Notes (CP/MTN/ICP/IMTN) Programme. The ratings reflect the credit strength of the corporate guarantee extended by its parent company, UK-based Tesco PLC (Tesco plc) for the rated facilities and MARC’s public information ratings on Tesco plc, the group’s strong global business profile in grocery retailing, its geographical diversity and relatively resilient margins. The rating outlook remains negative. This is premised on the fact that Tesco plc has yet to demonstrate tangible improvement in free cash flow generation either through increased cash inflow from operations and/or moderation in cash outflow for capital management programmes/initiatives as at end of August 31, 2008.
 
Tesco plc is the largest grocery retailer in UK, with an estimated 30.7% market share in the twelve weeks to December 28, 2008, and ranks as the third largest grocery retailer in the world after Wal Mart and Carrefour. It has operations in twelve countries outside UK in Europe, Asia and USA with a total of 3,729 stores covering 75.96 million sq. ft of retail space.

For the financial year ended February 29, 2008 (FY2008) Tesco plc recorded a revenue of £51.8 billion (FY2007: £46.6 billion) and pre-tax profit of £2,803 million (FY2007: £2,671 million). Its operating margin of 5.9% is reflective of levels recorded in earlier financial periods excluding FY2007, which benefited from a one-off gain arising from the Finance Act 2006 pension adjustment. Gearing increased to 0.74 times (FY2007: 0.59 times) due to continued bigger capital expenditure outlays. For the six months period ended August 31, 2008 (1H2009), Tesco plc continued to grow with revenue increasing 13.8% to £25.6 billion and pre-tax profit by 11.3% to £1,435 million, compared to the corresponding period last year. The revenue growth momentum was maintained in the latest third quarter performance results where Tesco plc announced preliminary double-digit revenue growth rates of 11.7%, underpinned by strong contribution from its international business especially Asian operations. In the near-term, MARC believes that Tesco plc’s profitability could come under pressure as the retailer focuses on becoming even cheaper for its UK and United States based operations due to rising economic pressures on consumers in these markets.

Tesco plc’s rather aggressive store openings in 2008, its £958 million acquisition of South Korean Homever discount chain as well as its buyout of Royal Bank of Scotland’s 50% stake of their personal finance joint venture had earlier exerted pressure on its credit metrics. Its aggressive expansion plans running concurrently with initiatives to return value to shareholders had resulted in negative free cash flows. More recently, Tesco plc has announced its intention to reduce the company’s discretionary cash flow deficit by reducing planned capital expenditure. This involves among others plans to reduce capital expenditure by £1 billion and achieve group net borrowings of around £8 billion by end of FY2009 from £10.0 billion currently. Despite the ongoing cash flow deficits of recent years, liquidity remains adequate. With its £2.4 billion Eurobond issue and undrawn banking facilities, Tesco plc estimates that it can comfortably meet its acquisition spending needs as well as its 2009/2010 upcoming debt maturities. MARC acknowledges Tesco plc’s efforts and commitment to strengthen its financial measures and will continue to monitor the impact of these measures on its credit profile.

Tesco Malaysia, owned 70:30 by Tesco plc and Sime Darby Berhad respectively, was incorporated on July 24, 2000 to operate hypermarkets in Malaysia. It commenced operations in 2002 with the opening of its maiden hypermarket in Puchong, Selangor Darul Ehsan. Currently it operates a total of 26 stores located in all major cities and states in Peninsular Malaysia under two formats, Tesco and Tesco Extra – Tesco Extra stores were formerly Makro stores of the Netherlands based Makro Group. Tesco Malaysia is currently the second biggest hypermarket operator in Malaysia.

For FY2008, Tesco Malaysia’s revenues surged 52.8% to RM2,563.7 million (FY2007: RM1,677.2 million) while operating profit grew fivefold to RM29 million year-on-year. However, pre-tax losses widened to RM37.7 million (FY2007: RM15.7 million) resulting mainly from high depreciation and amortisation charges due to continued capital expenditures incurred on infrastructure to boost the number of stores and achieve optimal operational efficiency through supply-chain advantages such as centralised warehousing and related IT facilities.

Notwithstanding the continued operating losses, Tesco Malaysia fulfils its financial objective of being self-sufficient in meeting its financing cost obligations from internal operating cash flows as imposed by its parent, with a net CFO interest coverage of 1.77 times as at end FY2008.

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