S&P: France-Based Retailer GROUPE FNAC Assigned 'BB' Rating After Acquiring Competitor Darty; Outlook Stable
We assigned our 'BB' rating to the group's recently launched €650 million senior unsecured notes. The recovery rating on the proposed debt is '4', indicating our expectation of meaningful recovery prospects in the higher half of the 30%-50% range.
We assess Fnac's business risk profile in the lower end of our fair category. Fnac operates in the highly competitive consumer electronics and editorial products business. It faces intense competition from internet-based retailers, discounters, and specialty retailers in segments--which combined equate to a sizable portion of its sales and product categories. In addition, the industry has witnessed the rapid obsolescence of certain product categories because of technological innovation, changing consumer preferences, and brisk growth of new product segments.
The group differentiates itself by providing speedy delivery times, emphasizing service capabilities that we think complement product sales in many categories, and matching its selling prices to other retailers' online and offline listings. The group has also found new levers of growth to balance the erosion of sales in declining business lines. These initiatives, along with cost reductions, have enhanced sales and margins, a trend we expect will prevail.
Moreover, we consider that acquiring Darty enables Fnac to become a strong market leader in France, with a fairly diversified business risk profile and lower seasonality in sales. The merger will also allow the enlarged group to have an online presence in the French market comparable to that of online retailer Amazon. Fnac will be able to generate merger-related synergies and pave the way for Fnac and Darty to share best practices across the wider group.
We view Fnac as a key retail channel for products of consumer electronics manufacturers such as Apple, Sony, Samsung, and LG Electronics. This is because, with the exception of Apple, they do not have a marked store presence in Europe. They consequently depend on Fnac's and other retailers' sales channels and consumer expertise.
We think that Fnac's strong French retail network, very well-known brand image in France, growing online presence, and focus on the store-within-a-store concept are some of the key factors that should enable the group to maintain good vendor relationships.
On the downside, we view the group's international footprint as still-limited despite the merger. In addition, Fnac's modest like-for-like growth and relatively low operating margin are still under pressure due to a highly competitive market environment. We also take into consideration potential merger execution risk, which could weigh further on current operating margins.
Our assessment of Fnac's financial risk profile reflects our view of the group's conservatively leveraged capital structure.
Under our base-case operating scenario, we forecast that the group's adjusted funds from operations (FFO) to debt will be 35%-40% and adjusted debt to EBITDA will about 2x over the next two years.
In addition, we forecast that the group will maintain an adequate liquidity position at all times. This reflects Fnac's lack of material debt amortization requirements and our forecast of positive free cash flow generation, thanks to improved working capital management.
Our rating incorporates our view of Fnac's relatively weak position compared with other companies with similar business and financial risk profiles. In particular, compared with larger European peers including Mediamarkt Saturn, the consumer electronics division of Metro AG, and Dixons Carphone, and Bestbuy in the U. S., the group's size and scale are relatively limited. In addition, we take into account the group's lack of track record, potential merger execution risk, and relatively meaningful leverage for a group operating in such a fast changing environment. As a result, we have assigned a negative qualifier for our comparable ratings analysis for Fnac. We nonetheless acknowledge that the 30% share component of the deal limits the company's leverage post-acquisition.
The stable outlook reflects our expectation of moderate but sustained improvement in revenues and earnings, underpinned by the recent strengthening in operating margins at both Fnac and Darty. We anticipate 1%-2% growth in same-store sales in the next year, albeit with the possibility of some volatility. We think the group will gain some upside from merger-related synergies, partially offset by the impact of restructuring costs and still-challenging trading conditions.
In the coming months, we will monitor the EBITDA margin particularly closely. However, we foresee satisfactory sales performance in 2016, along with healthy free cash flow. As a result of the group's planned limited dividend distribution in the next few years, we forecast a slight improvement in cash on the balance sheet, taking into account our projection that the group should generate about €50 million of discretionary cash flow in 2017, post transaction.
In our base-case assumptions, we forecast S&P Global Ratings-adjusted FFO to debt in the 35%-40% range and adjusted debt to EBITDA of about 2x.
We could consider a downgrade if the group's credit metrics weaken over the next 12 months, specifically if Fnac's FFO-to-debt ratio approaches 30%. In our view, this could occur if Fnac's like-for-like sales decline amid tough trading conditions, and if integrating Darty results in higher-than-initially-expected restructuring costs and unrealized synergies, leading to deterioration of operating margins. Negative rating pressure would also arise if liquidity weakened, including tightening covenant headroom. Lastly, a weaker-than-anticipated profitability (due to a marked deterioration of the competitive landscape, for example) would lead to a negative rating action as it could affect both our business risk profile assessment and the company's credit metrics.
In the near term, a positive rating action is unlikely as any upgrade would depend on material and tangible positive effects of the merger on the combined entity's business risk profile. We could take a positive rating action if we see business risk profile strengthening, on the back of a marked improvement in trading and margins and if Fnac strengthens its free cash flow generation, causing adjusted FFO to debt to move closer to 45%, with adjusted debt to EBITDA decreasing toward 1.5x on a consistent basis. Any upgrade would hinge on our view that the risk of releveraging is low, based on our assessment of the group's financial policy.