Credit Insights 02/22: DIV Grupa – izazov (re)financiranja
1. travnja 2022.Credit Insights 04/22: Croatia Airlines – how long can it go?
6. travnja 2022.The rating universe
Our portfolio of rated Croatian food retailers includes the 15 largest companies in the sector – Lidl, Spar, Kaufland, Plodine, NTL, Studenac, Tommy, KTC, Čakovečki mlinovi, Boso, Mlin i pekare, Ribola, Gavranović and Metro. Ten out of these 15 companies have their headquarters in Croatia, while five of them are subsidiaries of larger international groups. We applied the group rating approach for the ten companies domiciled in Croatia and one subsidiary of an international externally rated group, while for the remaining four subsidiaries of international groups we applied a standalone rating approach.
Food retail is generally moderately risky industry, and market position is the main differentiator between the companies’ business risk profiles
Food retail generally exhibits a moderate industry risk, with some differences within sub sectors. For example, discounters have proven to be more resilient during crises than general markets / supermarkets sub sector, while on the other side of the spectrum is food distribution, which counts only one company in our sample. In our rating universe we have one discounter (Lidl), one predominantly food distributor with some retail operations (Metro), and thirteen general markets / supermarkets largely differentiated in terms of geographical coverage (national chains, multi-regional chains, regional chains, local chains) and store formats (hypermarkets, supermarkets, and proximity stores).
Despite the generally same industry score for the whole rating universe, the business risk profile scores somewhat diverge due to a market position sub score. Namely, a company’s bigger size allows for better purchasing conditions, i.e., stronger bargaining power with suppliers, which is often reflected in gross margins the company can achieve. Also, larger companies normally achieve better fixed cost coverage due to their higher scale. Therefore, when assessing creditworthiness of food retailers, we advise to differentiate companies by their sales size. However, interestingly, in our rating universe there are four companies within top seven which have not achieved higher profit margins despite their size. The major reason behind is the high volatility of their profitability due to acquisitions / restructurings and fixed cost management issues.
Below is the business risk profile score distribution, with the majority of our food retail portfolio being scored within the moderate risk assessment (3 and 4).
Financial risk profiles of top 15 food retailers vary greatly, with almost half of the portfolio exhibiting elevated, high, or very high financial risk
Financial risk profiles assigned to the top 15 food retailers vary greatly, with almost half of the portfolio exhibiting elevated, high, or very high financial risk. Please be reminded that the financial risk profile shows how much debt can a company bear given its business risk profile (industry risk and competitive position).
The median net debt / EBITDA of our rating universe amounts to only 1,9x, which is considered low, and therefore positive. Nevertheless, there are five companies whose financial risk score has been negatively impacted by the additional notching down due to weak liquidity, elevated capital structure, or heightened financial policy risks. More precisely, four companies exhibit weak or very weak liquidity, and two companies exhibit negative capital structure and financial policy assessment, which largely constrains their credit ratings. Unfortunately, there are five food retailers (one third of the portfolio!) whose financial risk profile is deemed highly risky, and potential unfavourable market developments could easily result in default. Access to capital / bank credit lines will remain the key in their success due to weak liquidity, caused by a heavy reliance on short term financing.
Food retail is a low-margin business due to large fixed costs burden, limiting retailers’ space for errors
The chart below depicts the median cash flow waterfall of Croatian food retailers. The median EBITDA margin in our rating universe amounts to 7,4%, out of which the companies have to use 0,5% to cover interest and taxes (giving the FFO margin of 6,8%), additional 0,5% for investments in working capital to support growth (giving the NOCF margin of 6,3%), 4,3% for CAPEX (giving FCF pre-dividends of 2,0%), and 0,6% for dividends (which is indeed a discretionary cash outflow), resulting in a modest FCF margin of only 1,3%. This means that on average, a Croatian retailer has only 1,3% of its generated sales to cover financial debt. This leaves a minimum space for errors in their market execution.
* Please note the figures as shown do not add up due to rounding
60% of the analysed food retailers has a high-risk rating, with two of them exhibiting a 1-year probability of default higher than 10%
There are six food retailers in Croatia whose ratings we consider acceptable, i.e., low to moderately risky counterparts to do business with. Yet, there are nine companies below the line, i.e., with higher credit risks. It is worrying to see seven companies struggling to achieve a credit rating higher than B. Although some of them may not pose credit risks per se, as valuations in the Croatian food retail remain high enough to offset some of the risks, still, some of these weakly rated counterparts do not benefit from an attractive business model, where the key risk is “merely” high leverage, but rather their long-term sustainability is under a question mark. In addition, there is a number of companies with strategic issues, and especially those subsidiaries of larger international groups could be on the exit door from the small and relatively unattractive Croatian food retail market.
We believe that the risks in the sector will remain elevated due to an intensified competition (entrance of a new discounter), a largely debt-funded and highly-acquisitive nature of some market participants, and in some cases unbalanced financial policies.
For more detailed information about creditworthiness of Croatian food retailers, feel free to get in touch by e-mail to mario@creditanalyst.eu, the contact form on https://creditanalyst.eu/en/contact/, or call us on +385 98 920 17 13.
