Fitch Upgrades Carrefour to 'BBB+'; Outlook Stable

PARIS & LONDON--()--Fitch Ratings has upgraded France-based food retailer Carrefour SA's (Carrefour) Long-term Issuer Default Rating (IDR) and senior unsecured rating to 'BBB+' from 'BBB'. The Outlook on the Long-term IDR is Stable.

The rating upgrade is driven by Carrefour's business profile improvement, reflected in its sales recovery and rising profitability. We believe the improvement is structural and therefore comfortably sustainable, primarily underpinned by the successful turnaround of the French operations. More generally, since 2012 Carrefour has strongly improved the balance of its geographic coverage and its network diversification by format. We expect group's financial credit metrics to steadily improve in the next three years, progressively aligning themselves with 'BBB+' peers. Carrefour's deleveraging will now be driven by profit growth - reflecting the strengthened business model - rather than, as in 2012-2013, asset sales and/or restrained cash expenses. We expect the financial metrics enhancement to be driven by management's continuous application of a strict financial discipline supporting healthy financial flexibility.

KEY RATING DRIVERS

French Turnaround, Europe Stabilisation

Carrefour's core French operations have now been recording two years of positive like-for-like sales (excluding petrol and calendar effect) and EBIT growth. French EBIT increased by 40% between 2011 and 2014. The European operations' sales have started to recover and operating margin slightly improved in 2014. Europe is key to the group's performance as in 2014 it represented 71% of both consolidated sales and EBIT. The recovery confirms Carrefour's positive turnaround strategy started in 2012, underpinned by effective management and corporate governance.

Healthy Operating Performance Prospects

At its rating level, Fitch does not expect any loosening in management's measures to further consolidate its business model. They notably entail a comprehensive refurbishment programme in France and Brazil and the continuous implementation of a multi-format and multi-channel strategy and operating costs optimisation measures (IT, logistics etc). Such actions should support steady sales and EBIT growth. We believe improving results in France and Europe will be able to offset any possible weakening in Brazil's contribution in the next three years.

Structural Improvement in Operating Margin

Carrefour's EBIT margin rose above the 3% threshold in 2014 (3.1%). It was due to the turnaround of its core French operations and steady profitability improvement based on strong top-line growth in Latin America. It is underpinned by a better geographic focus with two strong country pillars (France and Brazil: 62% of 2014 group net sales), where Carrefour benefits from leading market shares and/or growth fundamentals are strong. Fitch believes this margin level is sustainable; however we anticipate consolidated EBIT margin will remain below 3.5% over the rating horizon which is a little weak within the BBB rating category for food retailers.

Furthermore, the group has considerably progressed in its shift from hypermarkets towards faster growing and more profitable convenience stores, whose network share increased from 14% in 2010 to 56% in 2014. The substantial optimisation of the group's commercial mix and cost base also supports profitability improvement.

Dia Acquisition

We expect Dia France to dilute Carrefour's French EBIT margin (10 bps decrease in 2016) at least up to 2018. Dia is currently unprofitable and could slow down the current restructuring of the French logistics network. However we believe the related integration risk is low due to management's expertise and its knowledge of the stores, which were spun-out from Carrefour only three years ago. Moreover the acquisition allows Carrefour to rapidly enlarge its convenience store network while reinforcing its market share in a highly competitive environment.

Free Cash Flow Positive, to Increase

In 2015 and 2016 Fitch forecasts that cash flow from operations (CFO) may not suffice to fully cover the group's large capex catch-up programme and dividends, were these fully paid in cash. Nevertheless, FCF generation should remain neutral or slightly positive, thanks to limited cash dividend outflows if a portion of dividends is paid in shares. From 2017 we believe the traction gained on sales and profitability, combined with the end of the capex programme should allow the group to pay its dividends fully in cash while generating consistently positive FCF. Our projections do not foresee any meaningful cash deployed for M&A.

Good Financial Flexibility

Financial flexibility is supported by the group's strong liquidity, well-spread debt maturities, healthy FFO fixed charge cover ratio and financial discipline. Management has a prudent shareholder policy and has publicly committed to improve cash flow generation. FFO fixed charge cover (2.3x in 2014) should improve to 2.7x in 2015, due to higher EBITDA and declining debt costs. The group's financial flexibility has been reinforced by the sale of 10% stake in Carrefour Brazil in 2014 (EUR525m proceeds) and 12.7m of treasury shares in March 2015 (EUR394m). The proceeds are being used to fund acquisitions and capex.

Financial Profile to Strengthen

Carrefour's main financial weakness is its relatively high leverage for its rating. Group lease-adjusted FFO net and gross leverage ratios (excluding financial services) at 4.1x and 4.8x at end-2014 are not yet commensurate with a 'BBB+' financial profile, due to the acquisitions completed in 2014 and a still relatively weak FFO margin, despite the improvement seen from the peak reached in 2012. Lease-adjusted FFO leverage, as defined by Fitch, is impacted by around 0.5x as we deduct dividends paid to non-controlling interests from FFO and only take into account EUR3.51bn readily available cash - this amount excludes EUR1.25bn that Fitch considers not readily available, as it is used to fund intra-year working capital seasonality.

However, Fitch believes the company enjoys strong deleveraging prospects, supported by the group's enhanced business profile and strict financial discipline. The BBB+ rating assumes steady profit growth and the maintenance of a conservative and strict financial policy leading to lease-adjusted net and gross leverage ratios trending down towards 3.5x and 4.1x respectively by end-2017, levels in line with the 'BBB' rating category median for the sector.

KEY ASSUMPTIONS

-Positive revenue growth driven by positive like-for-like sales development and acceleration of network expansion (including impact from 2014 acquisitions)

-Further EBIT margin improvement supported by France and Europe recovery (excluding Dia), resilience in Latin America

-EUR2.5bn to EUR2.6bn capex in 2015 and 2016, decreasing to annual EUR2.2bn thereafter

-Dividends: 50% paid in scrip in 2015 and 2016 (versus average rate of 66% in the last consecutive four years)

-Bolt-on acquisitions of EUR300m per annum, along with EUR200m annual proceeds from asset sales

-EUR394m proceeds from sale of treasury shares in 2015

RATING SENSITIVITIES

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

-Evidence of stores generating above average sales per sqm resulting in improving EBITDAR margin and above sector peers

-Group EBIT margin sustainable above 4%

-FFO fixed charge cover consistently above 3.5x

-FCF margin consistently at or above 1%

-Lease-adjusted FFO gross leverage (excluding financial services) at or below 3.5x on a sustainable basis (net of readily available cash: 3.0x)

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

-Group EBIT margin below 3%

-FCF neutral or negative on a sustained basis

-Maintenance of lease-adjusted FFO gross leverage (excluding financial services) above 4.0x (net of readily available cash: 3.5x)

-FFO fixed charge cover consistently below 2.5x

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.

Applicable criteria, 'Corporate Rating Methodology', dated 28 May 2014, are available at www.fitchratings.com.

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=983224

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Contacts

Fitch Ratings
Principal Analyst
Anne Porte
Associate Director
+33 1 44 29 91 36
or
Supervisory Analyst
Jean-Pierre Husband
Director
+44 20 3530 1155
Fitch Ratings Limited
30 North Colonnade
London E14 5GN
or
Committee Chair
Pablo Mazzini
Senior Director
+44 20 3530 1021
or
Media Relations
Peter Fitzpatrick, London, +44 20 3530 1103
peter.fitzpatrick@fitchratings.com

Contacts

Fitch Ratings
Principal Analyst
Anne Porte
Associate Director
+33 1 44 29 91 36
or
Supervisory Analyst
Jean-Pierre Husband
Director
+44 20 3530 1155
Fitch Ratings Limited
30 North Colonnade
London E14 5GN
or
Committee Chair
Pablo Mazzini
Senior Director
+44 20 3530 1021
or
Media Relations
Peter Fitzpatrick, London, +44 20 3530 1103
peter.fitzpatrick@fitchratings.com