Rating action

Scope Ratings has today affirmed its rating of BBB- to CECONOMY AG. The agency has also affirmed the short-term rating of S-2. The Outlook continues to be Stable.

Rating rationale

Scope views the recent change in management and the subsequently triggered restructuring as neutral for the ratings. The assessment also reflects the new management’s continuation of the conservative financial policy. However, execution risks remain regarding the new management’s restructuring programme and the further development of the omni-channel and service activities, with the latter prompted by the ongoing transformation of the retail industry. CECONOMY’s ownership structure continues to be credit-neutral, as Convergenta, the minority owner (21.6%) of MediaMarkt-Saturn Holding, has no voting representation at the CECONOMY level.

The business risk profile continues to be strongly supported by the group’s clear lead in European consumer electronics retail. This has not changed during the last 12 months, in Scope’s view, with the group growing at least in line with the market and continuing to catch up strongly in terms of its online business. Many customers seem to endorse CECONOMY’s hybrid offering, which combines a physical presence via stores – and the option to collect goods in person – with the convenience of e-commerce. Scope views CECONOMY’s profit warnings in the last 12 months to be purely cost-driven, while the topline continues to develop well.

Following poor profits in FY 2018 (fiscal year ending September), new management has laid the groundwork for an expensive, but thorough, restructuring, in Scope’s opinion. Main points include the removal of double functions for the two brands, Media Markt and Saturn, and the set-up of a common procurement policy. The country portfolio was also further optimised since 2017. Former ‘problem‘ countries were addressed: France, entry via the 24.3% Fnac-Darty stake; Russia, sale of own activities and acquisition of 15% stake in M.video; and the turnarounds in Turkey and Italy. Measures are ongoing for Poland, Sweden and the Netherlands and recently a joint-venture was created in Greece together with local Olympia Group. Given the present restructuring focus, market entry into the UK is unlikely during FY 2019. Thus, Scope believes the above measures have improved geographical diversification since last year. The ratings continue to be held back by profitability, but some upside from FY 2020 is likely if restructuring efforts succeed.

Scope’s financial risk assessment reflects CECONOMY’s strong balance sheet, which arose as part of the Metro demerger and was maintained despite the Fnac-Darty and M.video transactions and the profit warnings in FY 2018. Credit metrics improved significantly at the end of FY 2018 in a year-on-year comparison. This was driven by an equity increase of more than EUR 270m (from new shareholder freenet AG) and by a positive release of cash of about EUR 300m from working capital changes, caused by a jump in trade payables following the VAT campaign for both brands at the end of September As a result, free operating cash flow (FOCF) reached a record-high of EUR 52m. This led to an improvement in FOCF to Scope-adjusted debt (SaD), to 26% in FY 2018 from 9% in the year before, thus ranking far ahead of the BBB category for that metric.

In the current year, Scope expects working capital trends to normalise somewhat, given that the positive effect was so strong the year before. Cash absorption was negative EUR 295m for the first six months of FY 2019. While some catch-up in the second half of the year is likely, Scope still estimates about EUR -100m of cash consumption due to the expansion in working capital in FY 2019. Coupled with somewhat lower operating earnings from the sizeable restructuring measures, which are likely to only affect FY 2019, credit metrics are expected to be lower this year but still in line with Scope’s ratio guideline for the ratings. The exception is FOCF/SaD, which is likely to reach around break-even in Scope’s base case scenario and below the level required for the ratings. However, as this is likely to be confined to FY 2019, this ratio is expected to recover by FY 2020, depending on actual working capital trends. Scope’s assumptions on the future level of operating leases will increase slightly from FY 2019 due to the implementation of IFRS 16. Scope continues to view management’s financial policy as conservative, evidenced by the 2018 equity increase and the decision to cut the dividend to zero, signalling a strong commitment to maintain the investment grade rating.

The liquidity policy continues to be sound. Limited short-term debt maturities are amply covered by the high cash balance and multi-year undrawn committed bank lines, each at EUR 1bn at the end of March 2019.

Rating-change drivers

• Positive: successful execution of restructuring programme, increasing margins and free cash flow.
   
• Negative: change in financial policy leading to potential debt-funded M&A; inability to maintain FFO/SaD above 35% and SaD/EBITDA below 2.5x.

Stress testing & cash flow analysis
No stress testing was performed. Scope performed its standard cash flow forecasting for the company.

Methodology
The methodology used for this rating(s) and/or rating outlook(s) Corporate Rating Methodology is available on www.scoperatings.com.
Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default as well as definitions of rating notations can be found in Scope’s public credit rating methodologies on www.scoperatings.com.
The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The rated entity and/or its agents participated in the rating process.
The following substantially material sources of information were used to prepare the credit rating: public domain, the rated entity and Scope internal sources.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the rating or outlook action, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds on which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Regulatory disclosures
This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
Lead analyst: Olaf Tölke, Managing Director
Person responsible for approval of the rating: Philipp Wass, Executive Director
The ratings/outlooks were first released by Scope on 27 June, 2017. The ratings/outlooks were last updated on 20 July, 2018.

Potential conflicts
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
© 2019 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Analysis GmbH, Scope Investor Services GmbH and Scope Risk Solutions GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5 D-10785 Berlin.

Scope Ratings GmbH, Lennéstraße 5, 10785 Berlin, District Court for Berlin (Charlottenburg) HRB 192993 B, Managing Directors: Torsten Hinrichs and Guillaume Jolivet.