MARC has downgraded the long-term ratings of Tesco Stores (Malaysia) Sdn Bhd’s (Tesco Malaysia) RM3.5 billion Conventional and Islamic Medium-Term Notes Programmes to AA(cg) and AAID(cg) from AA+(cg) and AA+ID(cg) respectively. The short-term ratings on the Conventional and Islamic Commercial Papers under the same programmes have been maintained at MARC-1(cg) and MARC-1ID(cg) respectively. Concurrently, the outlook on the ratings is revised to negative. The rating agency has concurrently removed the ratings from MARCWatch Negative where they were placed on September 25, 2014. 

The ratings on Tesco Malaysia reflect the credit strength of the corporate guarantee on the rated programmes provided by its parent UK-based Tesco PLC (Tesco) on which MARC has lowered its public information rating from AA+/stable to AA/negative. The downgrade reflects the rating agency’s assessment on Tesco’s weakening operating performance and loss of competitiveness in its core UK market. For the first half of financial year ending February 28, 2015 (1HFY2015), Tesco registered a significant 41.0% year-on-year (y-o-y) decline in trading profit to £937.0 million despite a slight decline in revenue to £30.5 billion (1HFY2014: £31.9 billion), largely due to weak operating margins amid intense competition from its UK peers. The performance in 1HFY2015 also includes the downward adjustment of £118.0 million resulting from Tesco’s overstatement of profit expectations by £263.0 million. The remaining £145.0 million from the overstatement, which had been recognised in previous financial years, and higher administrative expenses and finance costs contributed to a 91.9% y-o-y decline in pre-tax profit to £112.0 million.

Notwithstanding the weakened profitability, Tesco remains the UK’s largest retailer by sales, commanding a retail market share of 28.8% for the 12 weeks to October 12, 2014. In addition, the retailer’s operations across 11 countries apart from the UK provide benefits from geographical diversification. MARC views Tesco to have a healthy liquidity position, as reflected by cash and cash equivalents of £2.9 billion as at end-1HFY2015 and undrawn borrowing facilities of £2.7 billion as at end-FY2014, to address its total short-term borrowings which stood at £3.0 billion as at end-1HFY2015. In addition, Tesco aims to preserve its cash flows by capping capital expenditure and reducing dividends.

Domestically, Tesco Malaysia recorded an improved performance in FY2014 with revenue increasing by 2.0% y-o-y to RM4,657.9 million and gross profit by 8.6% y-o-y to RM950.6 million. Coupled with sharply lower operating costs and higher rental income from tenants, pre-tax profit rose by 50.6% y-o-y to RM131.8 million in FY2014. In terms of store expansion, Tesco Malaysia added only three stores recently, two in FY2014 and one in 1HFY2015, bringing the total to 50 stores as at August 23, 2014. While Tesco Malaysia recorded stronger cash flow from operations to RM412.5 million (FY2013: RM380.6 million), the company continued to rely on financial support from the Tesco group to meet its financial obligations. Of its total borrowings of RM2,936.7 million (FY2013: RM3,186.8 million), intercompany loans stood at 89.4%, or RM2,626.3 million, in FY2014 (FY2013: RM2,810.3 million). Tesco Malaysia’s leverage improved with a debt-to-equity ratio of 8.0 times (FY2013: 11.6 times) on higher retained earnings. There is no outstanding balance under the RM3.5 billion rated programmes, which expire in 2024.

The negative outlook reflects MARC’s views that Tesco’s profit margins would continue to come under pressure in its primary UK market in the near term. The outlook could be revised to stable should the group’s strategies aimed at arresting the decline in Tesco’s business profile lead to an improvement in credit metrics.  

Contacts:
Ngiam Tee Wei, +603-2082 2268/ teewei@marc.com.my;
Yap Lai Ken, +603-2083 2247/ laiken@marc.com.my.