OREANDA-NEWS. Fitch Ratings has affirmed South Korea-based Lotte Shopping Co. Ltd's (Lotte) Long-Term Issuer Default Rating (IDR) and senior unsecured debt rating at 'BBB'. The Outlook is Stable.

The affirmation of the rating and Outlook reflects Fitch's view that Lotte's credit metrics will improve in 2016, although the rating headroom remains very thin, reflecting the weak performance in 1H15 caused by the Middle East Respiratory Syndrome (MERS) outbreak, slight same-store sales growth and capex cuts.

KEY RATING DRIVERS

Weak Operating Performance: Lotte's operating performance deteriorated in 2014 and 1H15, with weaker-than-expected consumer demand, rising rental expenses, and continued losses from overseas operations. Although same-store sales growth for domestic department stores and hypermarkets improved in April-May, 2Q15 performance was hit by the sharp drop in consumer demand following the outbreak of MERS in May-June. As a result, 1H15 revenue (non-financial operations) remained mostly flat while EBITDA declined by 14% yoy.

Limited Rating Headroom: Fitch expects Lotte's credit metrics to deteriorate in 2015 due to weaker-than-expected operations. Adjusted net debt to EBITDAR (non-financial operations) is expected to exceed our negative guideline of 4.5x in 2015. However we expect earnings to rebound from 2H15 after the one-off impact of the MERS outbreak in 1H15 and due to slight same-store sales growth. With earnings improvement and lower capex, we expect net leverage to improve to below 4.5x from 2016. Nevertheless we believe rating headroom is now very thin.

Continued Overseas Losses: Lotte continued to post losses in its overseas operations in 2014 and 1H15. Losses widened in 2014 due to restructuring in its Chinese hypermarket operations, which resulted in the closures of five underperforming stores, but losses narrowed in 1H15 following those closures. Given the sluggish growth in the offline retail market in China, we do not expect a major turnaround in the near term. However we expect losses to narrow slightly over the next few years with restructuring and slower expansion. Nevertheless we believe the company's overseas operations are not likely to break even in the next two to three years.

Capex Cuts: The company has been revising its investment plan since the beginning of 2015 given the sluggish market environment and pressure on credit metrics. We now expect Lotte's capex spending to fall to KRW1.4trn-1.5trn in 2015 and 2016, around 20% less than that in the past two to three years.

Strong Market Presence, Diversified Business: Lotte continues to be the dominant player in Korea's retail industry with the largest market share in the department store segment by revenue, which we believe will remain unchanged. Its ratings are also supported by its diversified business portfolio, which encompasses major retail formats such as department stores, hypermarkets, supermarkets, convenience stores, and outlets, which gives it economies of scale and mitigates exposure to cyclicality and market volatility.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for Lotte Shopping include:
-Non-financial revenue growth of 3%-4% in 2015 and 2016 reflecting the low base in 1H15 and modest demand growth
-Losses in overseas operations to decline gradually over the next two to three years
-Capex of KRW1.4trn-1.5trn in 2015 and 2016 in its non-financial operations

RATING SENSITIVITIES

Negative: Future developments that may, individually or collectively, lead to negative rating action include;
- Adjusted net debt/EBITDAR from non-financial operations exceeding 4.5x on a sustained basis (2014: 4.3x)

Positive: Future developments that may, individually or collectively, lead to positive rating action include;
- Adjusted net debt/EBITDAR from non-financial operations falling below 3.5x on a sustained basis
- Sustained recovery in the domestic retail industry