October 6, 2017 / 12:37 PM / 13 days ago

Fitch Rates Eurotorg 'B-(EXP)'; Proposed Notes 'B-(EXP)'

(The following statement was released by the rating agency) LONDON/MOSCOW, October 06 (Fitch) Fitch Ratings has assigned Belarus-based Eurotorg LLC an expected Long-Term Issuer Default Rating (IDR) of 'B-(EXP)' with a Stable Outlook. At the same time, Fitch has assigned an expected rating of 'B-(EXP)'/'RR4' to Eurotorg's proposed five-year loan participation notes (LPNs). The assignment of final ratings is contingent on the successful placement of LPNs and refinancing of Eurotorg's short-term debt maturities. Final documents should conform to information already received. The LPNs will be issued by Bonitron Designated Activity Company, an SPV domiciled in Ireland. The SPV will be limited to issuing the notes and providing a loan to Eurotorg. The notes will be secured by a loan to Eurotorg, which will rank equally with other senior unsecured obligations of Eurotorg. The 'B-(EXP)' IDR reflects our view that even after the intended refinancing, which should improve Eurotorg's liquidity position, the company's financial flexibility is limited by significant FX risks and a currently high debt burden. Positively, the rating is supported by Eurotorg's strong business profile, underpinned by the company's unrivalled position in Belarusian food retail market, limited entry threat from international chains, solid profitability and some growth opportunities arising from the low penetration of modern retail in the country. KEY RATING DRIVERS Largest Food Retailer in Belarus: The rating is supported by Eurotorg's strong market position as the largest food retailer in Belarus with a 19% market share by sales in 1H17. This ensures strong bargaining power with suppliers and should help Eurotorg preserve its gross margin and win market share from traditional retail, which accounts for 55% of retail sales in the country. Although the company is large by Belarusian standards, its absolute scale (2016 EBITDAR of around USD170 million) is smaller than other Fitch-rated food retailers and commensurate only with a 'B' rating category. Material FX Exposure: Limited financial flexibility stems from an inherent, material mismatch between the currencies of Eurotorg's profits and debt. As a company with only domestic operations, Eurotorg generates its profits in Belarusian roubles, while over 80% of its debt is in hard currency. In addition, the company's operating lease agreements are in euros, though it has some negotiation power with landlords in case of sharp local currency depreciation. In our sensitivity analysis, a depreciation of the local currency of a similar magnitude seen in 2015/16 would push leverage higher by 1x, partly mitigated by rising inflation in such scenario. LfL Sales Growth to Accelerate: We project Eurotorg's like-for-like (LfL) sales growth to accelerate to mid-single digits due to our expectation of stabilisation of consumer sentiment as Belarus' GDP resumes growth. The company's LfL sales grew a modest 1% over 2015-1H17 due to weak consumer spending, sales cannibalisation from rapid expansion in 2014-2016 and, most recently, a nationwide marketing campaign. We assume that none of these factors would have a material impact on sales over 2018-2020. EBITDA Margin Growth: Based on management accounts, Eurotorg's EBITDA margin increased to 9% in 1H17 (1H16: 5.5%) due to marketing activities and, to a greater extent, better terms from suppliers achieved at the expense of shorter payables days. We expect Eurotorg to maintain EBITDA margins at around current levels over the medium term. This is based on our assumption that cost efficiencies (especially in personnel expenses) would offset growth in operating lease expenses as the company opens new stores mostly on leasehold premises. FCF Partly Mitigates Refinancing Risks: We expect Eurotorg to generate positive free cash flow (FCF) at around 2%-3% of sales over 2017-2020, due to moderate expansionary capex and projected stable operating performance. Fitch also assumes that shareholders would stay committed to the company's deleveraging and accumulation of cash buffer ahead of the LPNs' repayment over 2021-2022. High Leverage to Decrease: Over 2013-2016 Eurotorg's funds from operations (FFO)-adjusted gross leverage had been within 5.5x-6.0x, which is commensurate with food retail peers in the 'B' rating category. Nevertheless, Fitch views these leverage levels as high for Eurotorg, given the company's inherent FX exposure and challenging operating environment in Belarus. Our rating assumes that Eurotorg's FFO adjusted gross leverage would fall below 4x over the next three years due to stabilisation in FX exchange rates and mild growth in consumer spending. However, deleveraging is contingent on the Belarusian rouble not depreciating sharply against the US dollar, the major currency of Eurotorg's debt. Limited Diversification: Eurotorg operates grocery and consumer electronics stores but the latter is immaterial relative to its core food retail operations and thus provides little diversification benefit. Geographic diversification is also limited as the company operates only in Belarus. Eurotorg's presence across different regions of the country puts the company in a better position than competitors but does not reduce concentration risks as Belarus is a small economy. Weak Corporate Governance: Eurotorg's lack of adherence to best corporate governance practices is a weakness for the company's credit profile. Eurotorg is a private company with limited information disclosure and key-man risk from two dominant shareholders. In addition, its financials have multiple restatements. A prudent financial policy targeting net debt/EBITDA of 3.0x and dividend suspension after 2014 provide some credit support. We therefore view corporate governance practices as neutral to the rating. DERIVATION SUMMARY Eurotorg's market position and bargaining power in Belarus is stronger than Russian peers X5 Retail Group N.V. (BB/ Stable), Lenta LLC (BB/ Stable) and O'Key Group S.A. (B+/ Stable). This is due to the large distance in market shares between Eurotorg and its next competitor and significant price advantage. However, in absolute terms based on annual EBITDAR, Eurotorg is substantially smaller than Russian peers. In addition, it has weaker credit metrics, more limited access to liquidity and, in contrast to Russian peers, material exposure to FX risks, which substantially reduces the company's financial flexibility. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - BYN/USD at 2.04 in 2017, 2.16 in 2018 and 2.31 in 2019; - 4% selling space CAGR over 2017-2020; - 9% revenue CAGR over 2017-2020; - EBITDA margin at 8.6%-8.7%; - Investment in working capital of around BYN100 million in 2017; - Capex around 1.5% of revenue over the next four years; - No dividends until net debt-to-EBITDA falls below 3x; and - No M&A. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to a Change of Outlook to Positive -FFO-adjusted gross leverage sustainably below 4.5x (2016: 5.5x) and FFO fixed charge coverage trending towards 2x (2016: 1.4x). -Sustained positive FCF and maintenance of conservative financial policy. The Belarus Country Ceiling being upgraded (currently B-) would be a pre-requisite for any upgrade consideration. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action -Inability to place LPNs and refinance short-term debt maturities, resulting in the liquidity ratio sustainably below 1x -FFO adjusted gross leverage sustainably above 5.5x and FFO fixed charge coverage trending to 1.2x due to operating underperformance, greater-than-expected debt-funded capex or sharp depreciation of Belarusian rouble LIQUIDITY Liquidity to Improve post-LPNs Issue: Although Eurotorg's liquidity profile is currently limited we expect it to strengthen substantially after the planned LPN placement and subsequent refinancing of short-term debt maturities. As at end-June 2017 Eurotorg's cash of USD14 million and expected positive FCF were insufficient to cover short-term debt of around USD90 million. After the refinancing pro-forma short-term debt would reduce to USD34 million and would be sufficiently covered by pro-forma cash of USD54 million. KEY RECOVERY RATING ASSUMPTIONS Average Recoveries for Noteholders: We expect to rate the potential LPNs in line with the Eurotorg's IDR of 'B-(EXP)', reflecting average recoveries in case of default under our going concern scenario. LPN will be issued by an SPV which is restricted to issuing notes and providing a loan to Eurotorg. The notes will be secured by a loan to Eurotorg, which will rank equally with the company's other senior unsecured obligations. Eurotorg is the major operating company within the group, accounting for 90% of the group's assets. The rights of noteholders would be structurally subordinated to those of senior secured lenders but we expect the amount of secured debt will decline over time, which would allow for average recoveries for noteholders. Key Recovery Rating Assumptions: The recovery analysis assumes that Eurotorg would be considered a going-concern in bankruptcy and that the company would be reorganised rather than liquidated. We have assumed a 10% administrative claim. Eurotorg's going concern EBITDA is based on LTM-June 2017 EBITDA. It reflects Fitch's view of a sustainable, post-reorganisation EBITDA level upon, which we based the valuation of the company. The going-concern EBITDA is 40% below LTM-June 2017 EBITDA to reflect significant FX translation risks. EBITDA discount is lower than for Ukrainian poultry producer MHP SE (45% discount) and slightly higher than for Ukrainian agricultural commodity processor Kernel Holding SA (35% discount). MHP and Kernel have lower exposure to FX risks than Eurotorg (export accounts for around 60% and 95% of revenue respectively). Nevertheless, we do not envisage a higher discount for Eurotorg as retail operations are less volatile than commodity trading and meat processing. An enterprise value (EV)/EBITDA multiple of 4.0x is used to calculate a post-reorganisation valuation and reflects a mid-cycle multiple. It is in line with EV multiples we use for Kernel and MHP and lower than the 5.0x EV/EBITDA multiple for Russian retailer O'Key Group SA due to a higher-risk jurisdiction. For the debt waterfall assumptions we used expected secured and unsecured debt at end-2017 after placement of LPN. This includes our expectations that by end-2017 the company will be able to repay some portion of secured debt. The debt waterfall results in a 34% recovery estimate corresponding to 'RR4' Recovery Rating for LPNs. This leads to our 'B-(EXP)' rating for the planned LPNs. Contact: Principal Analyst Anna Zhdanova, CFA Associate Director +7 495 956 2403 Supervisory Analyst Pablo Mazzini Senior Director +44 20 3530 1021 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chairperson Giulio Lombardi Senior Director +39 02 879087 214 Summary of Financial Statement Adjustments Operating Leases: Fitch adjusted Eurotorg's debt by adding 5x of yearly operating lease expenses (2016: BYN86 million). The 5x lease multiple is the same we apply in Ukraine, which has a similar long-term funding cost environment as Belarus as reflected in the 10-year government bond yields. Cash: We have adjusted available cash at end-2016 to reflect restricted cash of BYN20 million needed for seasonal changes in working capital requirements throughout the year. Bank Deconsolidation: We have deconsolidated JSC Status Bank from Eurotorg's consolidated accounts (P&L, balance sheet and cash flow statement), based on the company's disclosure. This is to reflect that Status Bank's lenders do not have recourse to Eurotorg and vice versa. No adjustment is deemed required as JSC Status Bank is small and immaterial to Eurotorg's operations (4% of group assets). In addition, the bank has very low leverage with 0.3x debt to equity in 2015-2016. Media Relations: Adrian Simpson, London, Tel: +44 203 530 1010, Email: adrian.simpson@fitchratings.com. Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. 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