Fitch downgrades PnP

2012-10-31 19:08

Johannesburg - Fitch Ratings has revised the outlook on Pick n Pay Holdings [JSE:PWK] Limited’s national long-term rating to negative from stable and affirmed it at ’A (zaf)’. The Short-term rating has been affirmed at ’F1 (zaf)’.

The Negative Outlook reflects the slower than expected pace of deleveraging until FY14, reflecting the increased pressure on Pick n Pay’s business profile in the highly competitive South African retail environment. This has been exacerbated by the delays and challenges faced with the execution of the group’s ongoing operating transformation strategy in an effort to meet changing dynamics within the South Africa retail sector. It also reflects the group’s significant exposure to consumer spending in the South African retail market, which has been negatively affected by decreasing disposable income as a result of increasing fuel and electricity prices, in addition to a rise in debt service costs.

Pick n Pay recently released interim results for the period ended August 2012, and reported a deterioration in gross margins to 17.6% from 18%, although this includes one-off costs, notably related to the Longmeadow distribution centre. Fitch expects that its rating headroom will remain limited as Pick n Pay continues to roll out new stores and transforms its supply chain models. Fitch now expects adjusted FFO leverage to increase to 3.5x at FYE13, and the EBIT margin to remain weak relative to its closest peers at below 2%. 

Leverage and margins could be further negatively impacted by cautious consumer spending in South Africa.

Despite short-term pressure on Pick n Pay’s business profile, the National Long-term rating has been affirmed at ’A’(zaf). This reflects the group’s strong business profile, including its strong market position in the domestic food retail industry and the diverse range of its product mix, including both branded and private products and Fitch’s expectation that sustainable steps are being taken by management under its transformation strategy set out in 2007/2008, such as the focus on reducing costs, better working capital management and supply chain focus. The current rating assumes a successful and timely implementation of the transformation strategy, Pick n Pay’s increased competitiveness as well as operating cash flow relief and EBITDA margin protection over the long term.

What could trigger a rating action?

Positive: Future developments that may, individually or collectively, lead to positive rating action include:

- Positive cash flow levels and FFO net leverage below 2.0x on a sustained basis

- Improvement in EBIT margin above 4%

- A prudent and sustained financial policy

Negative: Future developments that may, individually or collectively, lead to a further negative rating action include:

- FFO lease adjusted net leverage sustained above 3.5x by 2014

- Failure to improve EBIT margin above 3,5% by 2014

- Longer than expected turnaround strategy leading to an impaired financial profile or weakened competitive position and a significant deterioration in the working capital cycle.