DIFC - Dubai, January 27, 2020 -- Moody's Investors Service ("Moody's") today assigned a first-time Ba3 corporate family rating (CFR) and Ba3-PD probability of default rating (PDR) to Pepkor Holdings Limited (Pepkor). At the same time, Moody's has assigned a A3.za National Scale Rating (NSR) corporate family rating. The rating outlook is stable.
"The Ba3 and A3.za ratings assigned to Pepkor reflect its moderate leverage and the resilience of its business profile stemming from its leading position as South Africa's largest non-grocery retailer," says Lahlou Meksaoui, a Moody's lead analyst for Pepkor.
ASSIGNMENT OF RATINGS
Pepkor's Ba3 CFR and A3.za NSR CFR reflect the South Africa-based retailer's (1) very strong position in the South African retail market through its Pep and Ackermans clothing and general merchandise stores included in Pepkor's Clothing and General Merchandise segment, which makes up 88% of the group's operating profits; (2) the strong recognition of PEP as a brand amongst budget-conscious consumers with some upside to sales from down trading in periods of pressure on disposable income with growth largely maintained even in up economic cycles where its regular customer base spends more; (3) stable credit metrics over the past three years, including moderate leverage with Moody's adjusted debt/EBITDA of 3.1x and EBIT/Interest Expense of 2.9x for the fiscal year 2019 ended 30 September 2019; (4) good liquidity profile and conservative financial policies; and (5) protection from online clothing retailers with natural barriers given PEP and Ackermans low prices backed by an extensive and sophisticated sourcing and logistics supply chain that keep cost of doing business low.
The ratings also factor in (1) the expectation of challenging trading conditions in South Africa because of low consumer confidence and rising unemployment which are likely to affect Pepkor's furniture and building materials businesses the most; (2) limited geographical diversification outside of South Africa; (3) the risks related to the build-up and performance of the company's credit books, despite the moderately low credit contribution of 9% of group sales; and (4) the majority ownership by Steinhoff International Holdings N.V. (Steinhoff), a Netherlands incorporated investment holding company, which came under severe financial duress following accounting irregularities announced in December 2017 but which has agreed to a Company Voluntary Agreement (CVA) with creditors until 31 December 2021.
Pepkor is 71% owned by Steinhoff which faces an uncertain financial future once its CVA with creditors come to an end in December 2021. Other large shareholdings include (1) 8.77% attributed to Lancaster 101 (Pty) Ltd which is 50% owned by the Public Investment Corporation and responsible for investing the South African Government Employees Pension fund, (2) 3.66% attributed to Coronation Asset Management; (3) 1.77% attributed to Allan Gray; and (4) 1.75% attributed to Investec Asset Management. While Steinhoff's majority stake is a constraint to the rating, a number of factors mitigate the associated risk, in Moody's view. Importantly in 2018, Pepkor refinanced a ZAR16 billion shareholder loan with bank financing thereby removing the upstream guarantees previously provided in favour of Steinhoff. There are currently no cross guarantees or default between debt at the two companies. Pepkor's board comprises a majority of independent directors with Steinhoff only represented by two out of eleven directors. The company has a conservative publicly stated financial policy of achieving a reported net debt to EBITDA of 1x in the medium term and to pay dividends equal to a third of earnings.
Pepkor's liquidity position is sufficient to meet its operational, financial and capital spending needs of ZAR10.6 billion over the next 18 months as forecasted by Moody's. This situation is supported by cash of ZAR3.9 billion, funds from operations of ZAR 10.9 billion and undrawn multi-year committed credit lines of ZAR1.76 billion as of fiscal 2019. Free cash flows will be positive in the next 12 months, further supported by Pepkor's two largest shareholders, representing 80% of the group's issued share capital, who have committed to receive the dividend in respect of the 2019 financial year in the form of shares. This partly offsets the significant investments required to ramp up the credit books and new store openings. Furthermore, Moody's expects Pepkor to diversify its funding sources by accessing the local bond market.
RATIONALE FOR THE STABLE OUTLOOK
The stable outlook reflects Moody's expectation that debt/EBITDA will register 3x or below over the next 18 months and that liquidity will continue to be sufficient. The outlook further presumes no material adverse interference from the company's majority shareholder.
WHAT COULD CHANGE THE RATINGS UP/DOWN
Pepkor's rating is currently constrained due to the uncertainty that is created by Steinhoff's majority shareholding. Steinhoff's liquidity pressures could resurface after the standstill agreement entered into with creditors lapses at the end of 2021. The rating or outlook could benefit from a change in ownership as long as the company continues to perform in line with Moody's expectations while maintaining debt/EBITDA below 3x along with good liquidity and strong market positions.
Downward pressure on Pepkor's rating would result if (1) gross debt/EBITDA trends above 4x; (2) retained cash flow to net debt were to fall sustainably below 20%; or (3) EBIT/Interest Expense was not maintained above 2.5x. Furthermore, a downgrade could occur if Pepkor creditors' interests were weakened due to Steinhoff interference through its majority shareholding. Any marked deterioration in Pepkor's liquidity profile could also place pressure on the ratings.