July 10, 2017 / 3:07 PM / in 4 months

Fitch Affirms Lenta at 'BB'; Stable Outlook

(The following statement was released by the rating agency) LONDON, July 10 (Fitch) Fitch Ratings has affirmed Lenta LLC's Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) and senior unsecured bonds at 'BB'. The Outlooks on the IDRs are Stable. The affirmation reflects our expectations that Lenta will maintain conservative credit metrics relative to close sector peers, while executing its growth strategy and improving its market position. We assume that the company's strict financial discipline and control over costs should help protect the balance sheet amid strengthened competition, sales cannibalisation and weak consumer spending in Russia. The ratings remain supported by Lenta's good access to local funding and strong financial flexibility. KEY RATING DRIVERS Enlarging Business Scale: The ratings factor in our expectation of improvement in Lenta's market position and further growth in its EBITDAR to levels more commensurate with the 'BB' rating category. The company intends to become the third-largest food retailer in Russia by 2020, up from fifth-largest by sales in 2016. We assume Lenta's expansion strategy will be supported by its robust business model and growth opportunities in the Russian food retail market arising from its fragmented nature and still high proportion of traditional retail relative to modern chains. Reduction in LfL Sales: Lenta's like-for-like (LfL) sales declined by 1.7% in 1Q17 and we expect overall organic sales growth to remain under pressure in 2017. This is due to sales cannibalisation by own stores as well as increased competition in the market as consumer spending in Russia remains weak. This is reflected in our expectation of weak footfall and higher operating leverage in 2017. We expect Lenta will be able to mitigate this pressure by retaining tight control over personnel and other store costs (keeping them relatively stable as a proportion of revenue). Decreasing but Strong Margins: As previously, Fitch projects Lenta's EBITDA margin will reduce gradually to 9.2% by 2020 (2016: 10.4%) but remain strong compared with Russian and European food retail peers. The major drivers of lower margins will be rising operating lease expenses and margin sacrifices to withstand competition. This is despite our expectations that the company's growing scale is likely to result in greater bargaining power with suppliers. Moderate Leverage: Fitch expects FFO adjusted leverage to reduce slightly to 3.5x in 2017 (2016: 3.7x) and remain around that level over the medium term. Deleveraging in 2017 should be supported by shifting a portion of capex to 2018. This demonstrates the company's ability to manage leverage through the timing of its store roll-out programme and could be applied further should economic or business conditions become more challenging. The ratings assume the company will maintain its conservative and consistent financial policy. Mildly Negative FCF: Fitch projects Lenta's FCF to remain negative but the proportion of capex funded with operating cash flow should increase to 65%-80% (2016: 45%). This is because we now assume slower selling space expansion and therefore lower capex. Our forecast for operating cash flows in 2017 takes into account shorter trade payable days following trade law amendments in 2016, which came into full force in 2017. Healthy Financial Flexibility: Lenta has the strongest FFO fixed charge coverage (2016: 2.7x) of its Russian peers due to high levels of store ownership. Fitch projects the fixed charge cover metric to remain relatively stable at around 2.5x over 2017-2020, solid for the rating, although we factor in a growing share of leasehold stores due to fast expansion in the supermarket format. Lenta's financial discipline, access to external funding, limited FX exposure also supports the group's financial flexibility and mitigates its relatively weak liquidity ratio for the rating. Limited Format Diversification: The ratings are constrained by Lenta's limited diversification outside its core hypermarket format. Supermarkets accounted for only 4% of the group's sales in 2016 and Fitch expects this share to only grow to around 15% by 2020, despite Lenta's accelerated expansion under the format. However, we consider the move towards accelerating format diversification as credit positive if it does not dilute profitability on a sustained basis. Average Recoveries for Unsecured Bondholders: Lenta's bonds are rated in line with its Long-Term Local-Currency IDR of 'BB' as the bonds are pari passu with unsecured bank loans and there is no prior-ranking debt. The bonds' rating reflects our view of average recovery expectations in case of default. DERIVATION SUMMARY Lenta has a stronger business profile and better credit metrics than O'Key Group SA (B+/Stable). Lenta is rated at the same level as X5 Retail Group N.V. (BB/Stable) but has less headroom under its 'BB' rating, primarily because Lenta has lower scale and format diversification despite its stronger coverage metrics. X5's rating is constrained by weak FFO fixed charge coverage. In comparison with international retail chains, Lenta has smaller business scale and diversification than Chile-based Cencosud SA (BBB-/Stable) and French and Brazilian retailer Casino Guichard-Perrachon SA (BB+/Stable) but its credit metrics are substantially stronger. The weak operating environment in Russia contributes to a lower rating for Lenta relative to global peers, in line with our criteria. There is no Country Ceiling constraint on the ratings. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - 15% revenue CAGR over 2017-2020 driven primarily by increase in selling space - EBITDA margin gradually decreasing to 9.2% - Capex at 8%-9% of revenue - No external dividends paid by Lenta Ltd funded by Lenta LLC. - No large-scale debt-funded M&A - Maintained negative working capital position RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action Positive rating action is unlikely in the coming two years, unless there is a material improvement in Lenta's market position translating into EBITDAR of at least EUR1 billion, and subject to: - Solid execution of the company's expansion plan and good LfL sales growth relative to peers - Maintaining EBITDA margin at around 9% - FFO-adjusted gross leverage below 3.0x on a sustained basis - FFO fixed charge coverage above 2.5x on a sustained basis Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - A sharp contraction in LfL sales growth relative to close peers along with material failure in executing the company's expansion plan - EBITDA margin erosion to below 8% - FFO-adjusted gross leverage above 4.0x on a sustained basis - FFO fixed charge cover significantly below 2.5x - Deterioration of liquidity position as a result of high capex, worsened working capital turnover and weakened access to local funding LIQUIDITY Adequate Liquidity: As at 6 June 2017, Lenta's cash of RUB5.1 billion and available undrawn committed credit lines of RUB11.5 billion were insufficient to cover expected negative FCF and RUB27.5 billion in short-term debt. Nevertheless, we believe that the company's liquidity position is supported by capex scalability and Lenta's good access to bank loans and capital markets as evidenced by recent refinancing activities. As at 6 June 2017 Lenta had RUB23.8 billion of undrawn uncommitted credit lines. Contact: Principal Analyst Anna Zhdanova, CFA Associate Director +7 495 956 2403 Supervisory Analyst Jean-Pierre Husband Director +44 20 3530 1155 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chairperson Nikolai Lukashevich Senior Director +7 495 956 9968 Summary of Financial Statement Adjustments Cash: Fitch adjusted available cash at end-2016 by deducting RUB3.5 billion to reflect average working capital requirements throughout the year. Media Relations: Julia Belskaya von Tell, Moscow, Tel: +7 495 956 9908, Email: julia.belskayavontell@fitchratings.com; Adrian Simpson, London, Tel: +44 203 530 1010, Email: adrian.simpson@fitchratings.com. 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