Moody’s Investors Service has downgraded the corporate family rating (CFR) of Iceland VLNCo Limited to B2 from B1, and its probability of default rating (PDR) to B1-PD from Ba3-PD. Concurrently, it downgraded to B2 from B1 the ratings on senior secured notes issued by Iceland Bondco plc and due in 2020, 2021 and 2024. Nonetheless, the outlook is stable.
Headquartered in Deeside, Flintshire, United Kingdom, Iceland VLNco Limited is the parent holding company of the Iceland Foods Group. Iceland Foods is a privately held retail grocer that specializes in frozen and chilled foods. Founded in 1970, the company has expanded its reach over the years to become a national operator with 833 stores in Britain (as of March 28, 2014) targeting the value conscious market segment. For the fiscal year that ended on March 28, 2014, Iceland Foods reported revenues of approximately £2.7 billion.
Moody’s rating action, announced in London on January 22, primarily reflects Iceland’s weak operating performance compared with expectations – namely stronger-than-expected declines in like-for-like (LfL) sales and margins, and the investors service’s view that trading conditions in Britain will continue to be challenging. The UK grocery market is going through unprecedented structural changes, which has been triggered in no small part by the rise of hard discounters Aldi and Lidl, which has led to a high level of price cuts among the four large supermarket chains.
In response, Iceland undertook certain measures to protect and drive volumes such as reducing prices on a significant number of stock keeping units (135 out of 800 core frozen food lines in early July 2014), increased marketing expenditures and improved its Christmas product range. However, those measures were not sufficient to stabilize volumes as LfL sales for the six weeks ending January 2, 2015 (Christmas trading) were down 4.8%. That followed declines of 1.5% and 5.8% in the first and second quarters of FY15, respectively (decline of 3.7% in H1 FY15).
EBITDA margin, as reported by the company, was 5.2% in H1 FY15 compared with 7.5% in H1 FY14. As a result, gross debt/EBITDA on a Moody’s-adjusted basis increased from 5.8x as at FYE March 28, 2014 pro forma for the refinancing completed in July of 2014, to 6.7x as at LTM September 12, 2014 pro forma for the recent bond buy-back. Moody’s expects Iceland’s leverage to remain at elevated levels as the increasingly competitive environment among UK grocers will continue to impact the company’s LFL sales and margins and therefore hamper material de-leveraging in the next 12-18 months.
More positively, the ratings are supported by four factors:
- The company’s niche position in the food market, with a solid share of products and a strong brand identity
- Relative defensive positioning in the convenience and discount end of the market
- Ability to differentiate from other discounters through product innovation and the provision of home delivery and on-line services
- Good liquidity, as demonstrated by positive cash flow generation. This profile is also underpinned by a cash balance of £153 million as of January 2, 2015, an undrawn revolving credit facility (RCF) of £30 million, and no mandatory debt amortization prior to 2019.
Moody’s Investors Service assumes that the company will maintain sufficient headroom under its single drawstop financial covenant only applicable to its RCF and only tested when drawn above a certain threshold.
Looking Ahead
While Moody’s expects the current competitive pressures in the UK retail grocery market to persist for an extended period of time, the stable outlook reflects its expectation that Iceland will stem the decline in LfL sales and margins over the next 12 months, and that industry conditions will not materially deteriorate further. It is also anticipated that the company will continue to pursue its organic growth strategy and make no material debt-funded acquisitions, adhering to its financial policy of investing any excess cash in the business and in de-leveraging.
Given the latest action, a rating upgrade over the short term is unlikely. However, over time, Moody’s could upgrade the rating if there is a visible improvement in operating performance including positive LfL sales growth and improvement in margins. Quantitatively, there would be positive pressures if the adjusted debt/EBITDA ratio falls sustainably towards 6.0x and the company maintains an adjusted EBITA/interest coverage comfortably in excess of 2x, while generating positive free cash flow and keeping a solid liquidity profile.
The rating could be downgraded if any of the following conditions for maintaining a stable outlook are not met: Iceland’s Moody’s-adjusted debt/EBITDA ratio rises above 7.5x; its EBITA/interest coverage falls materially below 1.5x; or if the company fails to generate free cash flow.
