Fitch Revises Outlook on Lotte to Negative; Ratings Affirmed at 'BBB-'
06/09/2019 10:14
(The following statement was released by the rating agency) Fitch Ratings-Seoul-September 06: Fitch Ratings has revised the Outlook on South Korea-based Lotte Shopping Co. Ltd's (Lotte) Long-Term Issuer Default Rating (IDR) to Negative from Stable. The IDR and senior unsecured debt rating have been affirmed at 'BBB-'. The Negative Outlook reflects the pressure on the credit profile from lagging profitability in its domestic hypermarket, supermarket and electronics retail operations, and higher debt from stake acquisitions in various affiliates. As a result, we expect net leverage (adjusted net debt/EBITDAR) to remain above our negative sensitivity of 5.0x in the next two to three years. The Outlook could stabilise if the company can show meaningful recovery in its struggling domestic hypermarket and supermarket operations; maintain robust profitability in its core department store operations; and sustain net leverage at below 5.0x. A downgrade could result if recovery is delayed further and net leverage is sustained above 5.0x. The rating continues to be supported by a dominant position in Korea's department store industry and a diversified business portfolio, which encompasses major retail formats. Key Rating Drivers Hypermarket and Supermarket Losses: Lotte's total revenue fell slightly in 2018 but operating profit was down by 26% due to losses in its domestic hypermarket and supermarket operations and costs related to the closing of three Chinese department stores. Revenue and profitability rebounded in 1H19, with robust domestic department stores and overseas hypermarket operations. However, losses in hypermarkets and supermarkets and profit deterioration in Lotte Hi-mart (an electronics retail store chain) continued to put pressure on profitability.Uncertain Recovery Outlook: We expect full-year revenue and profit to improve in 2019, reflecting robust contribution from the department store segment, continued positive contributions from overseas hypermarket operations, and the addition of the Inchon department store through the stake acquisition in Lotte Inchon Development from Lotte Holdings. However, recovery prospects for the struggling domestic hypermarket and supermarket divisions remain uncertain due to sluggish demand and ongoing restructuring. Credit Profile Under Pressure: Lotte's net leverage ratio remained above our negative guideline of 5.0x in 2018, and we expect net leverage to remain around 5.3x in 2019-2020 due to the struggling domestic hypermarket and supermarket segments, and also with higher debt from the recent consolidation of three subsidiaries in which Lotte acquired stakes from its parent Lotte Holdings as part of group restructuring; net debt increased by KRW1.25 trillion and the cash paid was KRW398 billion. Lotte has also announced it will acquire 20% of Lotte Card for KRW325 billion in 2H19 after the Lotte Group sold its stake to a private equity fund.Meaningful Recovery and Deleveraging Needed: The Outlook could stabilise if the company can show meaningful recovery in its domestic hypermarket and supermarket operations which are currently making a loss; maintain robust profitability in its core department store operations; and deleverage to below 5.0x adjusted net debt/EBITDAR. Asset Sale and REITs IPO: We believe Lotte's credit profile is supported to a certain degree by ongoing asset sales and the potential IPO proceeds from Lotte REIT. Lotte has raised over KRW500 billion of cash YTD 2019 through the sale of its Chinese mart operations, two domestic department stores, and domestic hypermarket assets. We have not factored in our rating case, although we believe additional cash will come in with the planned IPO of its 100%-owned Lotte REIT, which owns six department stores and four hypermarket assets. Lotte plans to float 50% of its stake in October. Derivation Summary Within the APAC retail universe Lotte is well positioned against China's Golden Eagle Retail Group Limited (BB/Stable) and Hong Kong's Lifestyle International Holdings Limited (BB+/Stable), with its larger scale and stronger and more diversified market presence in various retail formats. It has a weaker financial profile, but we believe the gap in business profile justifies the rating differential. Lotte's financial profile is weaker than US investment-grade peers such as Macy's Inc. (BBB/Stable), Kohl's Corporation (BBB/Stable) and Nordstrom, Inc. (BBB+/Stable), which justifies the rating differential. However its similar size and better diversified business profile mitigate the weaker financial profile. We also believe Lotte's interest coverage ratio - which is weaker than its peers - is partly offset by the substantial rental income it receives, which has consistently been above the rental expense amount. Key Assumptions - 2019 revenue and profit to improve from 2018; EBITDA to improve by around 10%- Capex (net of contracted sales proceeds from project companies) of KRW 283 billion in 2019, KRW1.1 trillion-1.3 trillion a year in 2020-2021- Moderate dividend growth RATING SENSITIVITIES Developments That May, Individually or Collectively, Lead to Positive Rating Action (back to Stable Outlook) - Adjusted net debt/EBITDAR remaining below 5.0x on a sustained basis - EBITDAR/(interest+rental) sustained above 2.0x Developments That May, Individually or Collectively, Lead to Negative Rating Action- Adjusted net debt/EBITDAR exceeding 5.0x on a sustained basis - EBITDAR/(interest+rental) sustained below 2.0x - Significant margin deterioration Liquidity and Debt Structure Adequate Liquidity: Lotte's total reported debt was KRW8.9 trillion as of June 2019. Of that amount, KRW2.4 trillion was short-term debt, compared with cash and equivalents of KRW2.3 trillion. We believe liquidity is further supported by access to various funding sources and banking relationships as it is a major affiliate of the Lotte Group. ESG Considerations Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of 3 - ESG issues are credit neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity.For more information on our ESG Relevance Scores, visit www.fitchratings.com/esg Contacts: Primary Rating Analyst Jeong Min Pak, Senior Director +822 3278 8360 Fitch Australia Pty Ltd, Korea Branch 9F Kyobo Securities Building 97 Uisadang-daero, Youngdeungpo-gu Seoul 07327 Secondary Rating Analyst Shelley Jang, Director +822 3278 8370 Committee Chairperson Kalai Pillay, Managing Director +65 6796 7221 Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@thefitchgroup.com; Yee Man Ko, Hong Kong, Tel: +852 2263 9953, Email: alanis.ko@thefitchgroup.com. Additional information is available on www.fitchratings.com Applicable Criteria Corporate Hybrids Treatment and Notching Criteria (pub. 09 Nov 2018) https://www.fitchratings.com/site/re/10051058 Corporate Rating Criteria (pub. 19 Feb 2019) https://www.fitchratings.com/site/re/10062582 Corporates Notching and Recovery Ratings Criteria (pub. 23 Mar 2018) https://www.fitchratings.com/site/re/10024585 Country-Specific Treatment of Recovery Ratings Criteria (pub. 18 Jan 2019) https://www.fitchratings.com/site/re/10058988 Additional Disclosures Dodd-Frank Rating Information Disclosure Form https://www.fitchratings.com/site/dodd-frank-disclosure/10088395 Solicitation Status https://www.fitchratings.com/site/pr/10088395#solicitation Endorsement Policy https://www.fitchratings.com/regulatory ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://WWW.FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. 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