Rating action

Scope Ratings has today affirmed the issuer rating of B+ for JSC Nikora Trade (Nikora Trade). The agency also affirms the rating of BB- on senior unsecured debt issued by Nikora Trade. All ratings have a Stable Outlook.

Rating rationale

The rating benefits from Nikora Trade’s dominant market share in Georgia’s organised food retail market. The retailer is one of the pioneers in the creation of a nationwide food shop network, leading to a high market share of 19% in the organised market (defined as non-bazaar or brand affiliated shops) in 2017. 2018 saw a delay in Nikora Trade’s expansion plans due to difficulties in grid connections for new shops and with the recruitment of competent sales clerks. As a result, 61 shops opened in October 2018, compared to management expectations of 200 at year-end 2018. This setback has not changed Scope's view on the group’s growth because the agency took the precaution of factoring in some postponements in the opening of new shops. Nonetheless, management has now announced a change in its expansion ambitions by focusing on more organic growth from 2019 onwards. Scope views this strategy positively because the group benefits from strong business competition tailwinds (e.g. the gradual disappearance of unorganised retail’s market share and limited development potential for Carrefour across the country). The new strategy will also reduce capex pressure on cash flows.

The rating benefits from Scope's expectation that Nikora Trade’s bargaining power with suppliers will increase, supported by: i) its anticipated strong growth potential; and ii) access to the various fast-moving consumer goods-producing entities of the holding company (Nikora JSC), spearheaded by meat producer Nikora LLC, which commands over 30% of Georgian market shares. This is advantageous for the rating because Scope expects internal suppliers to propose more flexible commercial terms than external suppliers.

Scope believes that Nikora Trade is less diversified than some of its competitors because the company is solely active in Georgia and does not offer any online services. While the latter point is not overly relevant for the rating, given the level of development in Georgia, Scope does not consider Nikora Trade to be sufficiently diversified either within the context of the small size of the domestic market or in comparison to its larger retail peers.

With a Scope-adjusted EBITDA margin above its peers (historically between 8%-9%, jumping to 11% in 2017 but decreasing to 10% in 2018), Nikora Trade has managed to monetise its vertically integrated structure relatively efficiently. As mentioned above, the company sells a significant share of goods which are manufactured and/or processed within the group. In Scope's view, this integration leads to relative cost and price advantages, and to a better management of unsold products in some cases, decreasing losses. Scope expects the size of the unorganised retail market to shrink and that Nikora Trade will be able to capture some of this market in future. Nikora Trade should therefore manage to increase its bargaining power with suppliers over the coming years. Nonetheless, due to the delays in the opening of new stores and the increase in rents, Scope affirms its EBITDA margin forecast at the current level (approx.10%) representing the new strategy towards more organic development.

As regards Nikora Trade’s financial risk profile, Scope sees adjusted indebtedness within the low BB category (with Scope-adjusted debt [SaD]/EBITDA at 3.6x in 2018 and funds from operations [FFO]/SaD at 21%). Free operating cash flow (FOCF)/SaD was most impacted in 2018, due to the sharp increase in capex while EBITDA remained stable, leading to negative FOCF (around GEL 25m). Scope expects a recovery in the coming years due to decreasing capex spending and a better monetisation of existing shops.

In order to address this situation, management has issued a substantial amount of equity (GEL 11.475m), alleviating the weight of debt on liquidity. Scope has applied a negative notch for liquidity due to limited availability of unrestricted liquidity relative to short-term financial maturities. The drop in EBITDA led to a covenant breach (the interest cover ratio) in 2018, waived afterwards by all the bondholders. A modification of the calculation method for this ratio should provide some leeway to the retailer and decrease the probability of a future breach if it is performed this year. Scope expects an additional covenant breach in 2019 if the method for calculating the interest cover ratio is not modified. The agency has, however, received a prospective waiver from the bondholders of a future covenant breach for YE 2019, limiting the risks on the instrument.

Going forward, Scope expects metrics to improve due to Nikora Trade’s new, more organic strategy. This change will impact the retailer on different levels. Scope expects a lower growth rate for annual sales but opex/depreciation and amortisation should be under better control, ensuring more stable profitability. Cash levels should also be higher due to better cash flow generation, unburdened by capex, leading de facto to less pressure from capex on FOCF generation. Scope's forecasts remain cautious but show an improvement in every ratio over the coming years.

Scope reflects the evolving dynamics of both the Georgian country and the retail industry with a more conservative interpretation of financial credit metrics. This is to account for potential downside in fast-moving economies and industries such as the retail industry in Georgia because the food retail segment appears to be undergoing strong consolidation at present, potentially changing competitive dynamics profoundly in the near future.

Among the supplementary ratings drivers, Scope does not expect financial policy to become an issue for the ratings as Nikora Trade does not have a track record of implementing an aggressive shareholder remuneration policy or entering into expensive M&A transactions. Scope also understands – and the rating assumes – that corporate governance matters with regards to debt-holder protection vis-à-vis shareholders are addressed adequately within the company as stipulated and monitored by the Georgian capital markets regulation via the National Bank of Georgia.

Scope also looks at recovery values for bondholders in a hypothetical case of default. The agency calculated a recovery rate of about 100% for the USD 10m senior unsecured bond, considering existing secured bank loans ranking ahead and that some of the foreign-currency-denominated debt could appreciate in local currency, as well as emerging market risk for bankruptcy resolution. This results in a rating of BB-, one notch higher than the issuer rating.

Rating-change drivers

The Outlook is Stable and reflects Scope’s expectation that Nikora Trade will maintain its credit metrics at the current level for indebtedness (SaD/EBITDA< 4.0x and FFO/SaD>15%).

A positive rating action could result from an FFO/SaD of above 30%, a SaD/EBITDA of below 3x and a significant improvement in liquidity on a sustainable basis.

A negative rating action could result from a deterioration in credit metrics, e.g. by FFO/SaD falling below 15%, SaD/EBITDA increasing above 4.0x and liquidity declining significantly on a sustained basis.

Stress testing
No stress testing was performed.

Cash flow analysis
Scope performed its standard cash flow forecasting for the company.

Methodology
The methodology used for these ratings (Corporate methodology 2019) 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 definitions of default and rating notations can be found at https://www.scoperatings.com/#governance-and- policies/rating-scale.
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, the rated entities’ agents, 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: Thomas Faeh, Executive Director
The ratings/outlooks were first released by Scope on 15.08.2019. The ratings/outlooks were last updated on 02.03.2018.

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
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