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Press Release: S&PGR Ups Russian Grocery Retailer X5 To 'BB'; Outlook Stable

3 Apr 2017 10:15 am
 
 
The following is a press release from Standard & Poor's: 
 
     -- X5 continued to deliver robust operating performance in 2016, despite 
difficult economic conditions, and we believe that the company will achieve 
strong organic growth over the next two years while maintaining its prudent 
financial policy. 
     -- X5's credit metrics improved in 2016 thanks to strong sales and EBITDA 
growth that resulted in reduced leverage. 
     -- We are therefore raising our ratings on X5 and its subsidiary X5 
Finance to 'BB' from 'BB-'. 
     -- The stable outlook on X5 reflects our view that the group will defend 
or strengthen its already sound position in the Russian food retail market. We 
consider a ratio of adjusted funds from operations to debt of well above 20% 
and adjusted debt to EBITDA of close to 3.0x over the next few years to be 
consistent with the current rating. 
 
LONDON (S&P Global Ratings) April 3, 2017--S&P Global Ratings raised its 
long-term corporate credit ratings on Russian grocery chain X5 Retail Group 
N.V. (X5) and its subsidiary OOO X5 Finance to 'BB' from 'BB-'. The outlook is 
stable. 
 
The upgrade reflects X5's continuing strong operating performance and further 
improvements in credit metrics, despite challenging economic conditions in 
Russia. Revenues grew in the double digits for the third consecutive year in 
2016, with like-for-like sales increasing by the high-single digits, albeit at 
a slower pace owing to declining food price inflation, throughout 2016. At the 
same time, X5 continues to improve profitability, with reported EBITDA margin 
growth of 55 basis points (bps) in 2016 and with a 38% increase in reported 
EBITDA in absolute terms. 
 
X5 reported overall 28% revenue growth (in ruble terms) in 2016, with revenues 
from the largest format, Pyaterochka proximity stores (accounting for 75% of 
revenues) growing in excess of 30%, mostly supported by new store openings. 
Despite a continuing decline in food price inflation, X5 maintained positive 
like-for-like sales and traffic growth. While we expect X5 to continue to 
increase revenues by 20%-25% over the next two years, mainly driven by further 
chain expansion, we believe that growth will slow over time because of intense 
competition and eventual saturation of the Russian food retail market. 
 
We take into account X5's leading position in the Russian food retail segment 
and its strong position in the lucrative Moscow and St. Petersburg markets. 
The group benefits from the resilience and predictability of this industry. 
 
X5's operations are concentrated mainly in Russia's central and northwest 
regions, and the group has good format diversity, with operations in the 
economy, supermarket, hypermarket, and convenience retail segments, with about 
75% of its sales coming from the proximity-stores format. We view X5's 
profitability in terms of reported EBITDA margins of 7.4% and net profit 
margin of 2.2% in 2016, which are weaker compared to its closest peer, PJSC 
Magnit (with respective margins of 10% and 5%). However, compared to other 
European peers in food retail, such as Tesco Plc, REWE Group, and Ahold 
Delhaize N.V., X5 has stronger profitability. 
 
Still, we note that the group's geographic concentration in the Russian market 
and exposure to emerging-market risks, such as currency volatility, persistent 
cost inflation, and political uncertainty, are the main constraints for the 
business. 
 
The group's financial risk profile reflects its continuing growth strategy, 
which includes new store openings. We expect capital expenditures (capex) to 
continue weighing on X5's cash flows, and we do not expect the company to 
deleverage materially over the next one to two years. At the same time, we 
expect those investments to gradually contribute to X5's earnings and cash 
flows. 
 
We have included the net present value of future operating leases in our 
credit metrics calculations in line with other rated companies in the retail 
sector. Historically, we didn't adjust X5's metrics for operating leases due 
to the absence in X5's financial statements (under International Financial 
Reporting Standards disclosure) of the commitments under future lease 
payments, owing to the cancellable nature of these rental contracts. Now we 
add to the group's financial debt our estimated operating lease adjustment. As 
a result, the adjusted debt to EBITDA for 2016 increased to 3x from 2x 
(unadjusted) and funds from operations (FFO) to debt decreased to 23% from 38% 
(unadjusted). Both metrics are well positioned in our significant financial 
risk profile category. In addition, we have removed our negative comparable 
ratings analysis modifier that we previously incorporated to offset the boost 
to X5's credit metrics and financial risk profile from not adding operating 
lease adjustments to debt. 
 
We expect X5 to maintain its prudent financial policy with a leverage target 
of no more than 2.75x reported net debt to EBITDA and no shareholder 
distributions in the medium term. In addition, we currently view the risk of 
sizable debt-financed acquisitions as low. 
 
The stable outlook on X5 reflects our view that the group will defend or 
strengthen its already sound position in the Russian food retail market. 
Following the turnaround during the past few years, we anticipate that a mix 
of focused organic expansion and the absence of large debt-financed 
acquisitions will enable X5 to continue improving its EBITDA generation. In 
light of the significant amount of capex on expansion of the store chain, we 
expect the reported FOCF to be negative. We consider a ratio of adjusted FFO 
to debt of well above 20% and adjusted debt to EBITDA of close to 3.0x over 
the next few years to be consistent with the current rating. 
 
A negative rating action might result if worsening operating performance or a 
deviation from the company's current financial policy in the form of 
large-scale debt-funded acquisitions causes X5's adjusted FFO to debt to fall 
below 20%. We would also lower the rating if adjusted EBITDA interest coverage 
falls below 3x or if we perceive a deterioration in liquidity to below our 
adequate level. 
 
We could consider raising the rating if sales and profitability rose more 
strongly than we anticipate, and if as a result of this, the group starts 
generating meaningful reported FOCF. We would consider raising our rating if 
our adjusted FOCF to debt improves to above 15% and adjusted debt to EBITDA 
below 3x on a sustainable basis, and if management commits to maintaining such 
ratios. A positive rating action would hinge on X5 further growing its market 
position, achieving stronger profitability, and maintaining adequate liquidity 
through advanced refinancing of its upcoming debt maturities and a prudent 
financial policy. 
 
RELATED CRITERIA 
 
     -- Criteria - Corporates - Recovery: Methodology: Jurisdiction Ranking 
Assessments, Jan. 20, 2016 
     -- Criteria - Corporates - General: Methodology And Assumptions: 
Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014 
     -- Criteria - Corporates - General: Corporate Methodology, Nov. 19, 2013 
     -- Criteria - Corporates - General: Corporate Methodology: Ratios And 
Adjustments, Nov. 19, 2013 
     -- Criteria - Corporates - Industrials: Key Credit Factors For The Retail 
And Restaurants Industry, Nov. 19, 2013 
     -- General Criteria: Country Risk Assessment Methodology And Assumptions, 
Nov. 19, 2013 
     -- General Criteria: Group Rating Methodology, Nov. 19, 2013 
     -- General Criteria: Methodology: Industry Risk, Nov. 19, 2013 
     -- General Criteria: Methodology: Management And Governance Credit 
Factors For Corporate Entities And Insurers, Nov. 13, 2012 
     -- General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009 
     -- Criteria - Corporates - General: 2008 Corporate Criteria: Rating Each 
Issue, April 15, 2008 
 
Certain terms used in this report, particularly certain adjectives used to 
express our view on rating relevant factors, have specific meanings ascribed 
to them in our criteria, and should therefore be read in conjunction with such 
criteria. Please see Ratings Criteria at www.standardandpoors.com for further 
information. Complete ratings information is available to subscribers of 
RatingsDirect at www.globalcreditportal.com and at spcapitaliq.com. All 
ratings affected by this rating action can be found on the S&P Global Ratings' 
public website at www.standardandpoors.com. Use the Ratings search box located 
in the left column.  Alternatively, call one of the following S&P Global 
Ratings numbers: Client Support Europe (44) 20-7176-7176; London Press Office 
(44) 20-7176-3605; Paris (33) 1-4420-6708; Frankfurt (49) 69-33-999-225; 
Stockholm (46) 8-440-5914; or Moscow 7 (495) 783-4009. 
 
Primary Credit Analyst: Natalia Goncharova, London +44(0)2071763018; 
                        natalia.goncharova@spglobal.com 
Secondary Contact: Raam Ratnam, CFA, CPA, London +442071767462; 
                   raam.ratnam@spglobal.com 
Additional Contact: Industrial Ratings Europe; 
                    Corporate_Admin_London@spglobal.com 
 
 
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