Woolworths (WOW) shares were sold off yesterday in the markets big surge for a second day after Moody’s downgraded the retailer’s credit rating, warning the supermarket giant faces a series of continuing challenges.
Moody’s trimmed Woolies’ rating to Baa2 from Baa1, citing the “continued operational challenges across much of its portfolio” for the retailer.
Woolworths last week revealed a December half loss of $972.7 million, its first loss in more than 20 years, with earnings hammered by stiff competition in supermarkets and general merchandise, and the more than $3.2 billion of impairments in the Masters hardware chain.
The downgrade left Woolies’ rating only two notches above “junk” rating as Moody’s maintained its negative outlook, meaning there could be a further downgrade in the next 18 months.
The shares lost more than 1% to $22.30 as the wider market jumped 2% on the day.
WOW 1Y – More pressure on Woolies
“The trend in comparable-store sales growth at its core Australian food and liquor business has been negative for the past three quarters and Woolworths does not expect a significant improvement in the [second half of this financial year]," Moody’s said in a release.
"The [first half] result highlights the loss in market share and margin erosion in the supermarket business, only partially offset by the continued strong performance in liquor."
Moody’s did acknowledge that the Woolies still had a strong market position, but wondered if that might be threatened by the moves to exit Masters hardware.
Moody’s said that while the impending exit from the failed home improvement business, was a “long-term positive from a credit perspective” it will require a high level of management attention and “Moody’s believes that there may remain a risk that unexpected cash costs could [affect] the firm’s financial profile".
For Woolies outlook to return to a stable rating, Moody’s said it would be looking for comparable-store sales growth in the core Australian Food and Liquor business to revert to a positive number on a sustained basis.
At the same time Moody’s would expect to see the debt to EBITDA ratio below 3.75 times and EBIT/interest expense to be above 4 times. Meaning Moody’s wants to see falling debt and debt cost and rising earnings before tax. That could be achieved by cutting debt levels, lifting sales and profits (through cost cuts as well) or keeping debt steady and raising revenue and profits.
“Given the negative outlook, a rating upgrade in the next 12-18 months is not likely,” Moody’s said.
"For an upgrade to be considered once the outlook is stabilized, comparable-store sales in the Australian food and liquor business would need to revert to a positive number, the general merchandise division would have returned to growth, and the exit from the Home Improvement segment would need to be well progressed, with an outcome in-line with expectations.
“The rating could be downgraded if comparable-store sales in the Australian food and liquor business deteriorate further or remain negative in FY2017, and/or the general merchandise division keeps underperforming, and/or the exit from the home improvement segment results in cash costs in excess of expectations, including the valuation of the put option,” Moody’s said.
Indicators of downward rating pressure would include debt/EBITDA ratio of 4.25 times and/or EBITA to interest expense below 3.3 times – other words falling earnings and static or rising debt levels and interest costs/coverage.
