Tesco's credit rating downgraded to 'junk' status

By Erin Smith

Published: 12 January, 2015

Global credit rating agency Moody's has further downgraded Tesco long-term credit rating from Baa3 to Ba1, which is considered "junk" grade for investments that are considered 'high risk'.

Sven Reinke, Moody's vice president and senior analyst for Tesco, said: "We have downgraded Tesco's ratings because of our expectation that the structural changes in the UK grocery retail market will continue to challenge the company's operating performance even with the benefits of the significant restructuring actions announced by the company."

Last week Dave Lewis, the chief executive who joined Tesco in September 2014 just before its £263 million profits overstatment was announced, shared his plans to help turn the business around. Lewis confirmed 43 Tesco stores are set to close and plans for 49 future stores are on hold.

Despite the strategy outlined by Lewis, Reinke stated that part of the credit downgrade reflects that the benefits gained through the cost-saving measures would take time to be realised. He said: " We think that the company's efforts to stabilise the UK operations and to protect the balance sheet, while helpful, will take time to implement and the company's financial profile is likely to remain leveraged beyond what we consider to be commensurate with an investment grade profile."

According to the Moody's general credit rating a 'Ba' credit rating on long-term obligations "are judged to have speculative elements and are subject to substantial credit risk." Further, Moody's also downgraded the company's short-term rating, which now falls outside the parameters of Moody's rating scale. Moody's has downgraded the short-term rating to 'Not Prime' which means "issuers (or supporting institutions) rated Not Prime do not fall within any of the Prime rating categories."

According to statement released by Moody's on Friday the downgrade reflected that in the relatively near future, the UK grocery market will continue to face fierce competition and continued pressure on profit margins for all players. "Today's rating action primarily reflects Moody's view that the increasingly competitive environment among UK grocers will foster continued pricing pressures that could result in a permanent reduction in average operating margins in the industry to the 3%-4% range."

Moody's identifies three fundamental challenges that continue to plague the supermarket giant including "(1) price pressure from the growing discounters; (2) the high level of price cuts among the four large supermarket companies; and (3) the consumer trend towards shopping at convenience stores and online shopping outlets while moving away from large, out-of town supermarkets and hypermarkets, which are Tesco's dominant UK formats."

The ongoing problems Tesco has faced since the middle of last year, allied with the company's continued financial decline has raised concerns with the credit rating agency. "Tesco's UK operations have suffered persistent sales declines and its trading margin for H1 2015 fell to 2.3% from 5.2% a year earlier."

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