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Rating action

Scope Ratings GmbH (Scope) has today affirmed the issuer rating of B+/Stable to Nikora Trade JSC. Scope has also affirmed its BB- rating for senior unsecured debt.

Rating rationale

The affirmation is driven by the company’s solid development despite constrained operations during lockdowns. Nikora Trade faced some operating challenges during the Covid-19 pandemic, with the adverse effect of the lockdown and the reduction of working hours. During the second wave of the pandemic in H2 2020, this trend started to reverse as the overall panic subsided and safety measures in retail stores were applied efficiently. At the same time, revenue growth of 19% YoY (in line with Scope’s and management’s forecast) was supported by the high resilience of the sector. This remained primarily fueled by new store openings, further benefitting from the gradual substitution of unorganised fast-moving consumer goods retailers. The company repaid its bond obligations in August 2021 and is currently in the process of issuing a new bond with similar terms.

Nikora Trade’s business risk profile (assessed at BB-) benefits from the company’s leading position in the Georgian retail market in terms of sales and trading area. In 2019-2020, the big players’ market share decreased due to the more rapid expansion of several fast-moving consumer goods retailers. In that period, Nikora Trade became the largest player with around 19% in market shares, overpassing Carrefour (the second largest) by 200 basis points. Management has maintained its expansion strategy by opening new stores and ramping up newly opened locations.

Diversification remains one of the weaker elements in the company’s business risk profile. There are no sales outside of Georgia, leaving the company exposed to macro-economic swings of the home country. While Tbilisi is seen as the linchpin of Nikora trade’s business operations, sales could be further diversified through unlocking the growth potential outside Georgia’s capital. Scope does not place too much emphasis on the single distribution channels, as e-commerce is still in a nascent stage in Georgia.

Nikora Trade’s flat profitability is the main supporting element of its business risk profile. The company’s margins proved robust during the Covid-19 pandemic. Despite the increased operational costs and additional safety or regulatory standards, Nikora Trade managed to keep a comfortable Scope-adjusted EBITDA margin at around 9%. The restated costs allocation due to inventory shrinkage and obsolete inventory costs for the years 2019-2020 decreased gross margins to 25% from 27%. The adjusted EBITDA return on assets is gradually increasing and Scope expects it to remain above 20% going forward, thanks to rapid EBITDA growth.

Scope believes that Nikora Trade will be able to keep profitability margins at the current level going forward. These will be supported by: i) historically stable gross margins of around 25%, benefitting from the vertically integrated group structure with advantageous commercial terms; and ii) the company’s growth strategy, which should continue to enhance its bargaining power, potentially creating higher margins. A heavy dependence on imported materials, a common characteristic of the Georgian retail market, may put Nikora Trade’s gross margin under further pressure if the Georgian currency continues to devalue against the euro/US dollar in 2021-2023.

Nikora Trade’s financial risk profile (assessed at B+) is supported by a comfortable cash conversion cycle, reflected in substantial cash flow generation. Slightly deteriorated operating performance due to the Covid-19 pandemic was boosted by a governmental subsidy in 2020 and is expected to benefit from a further subsidy in 2021. In addition, Scope views positively the company’s financial flexibility in terms of capital spending with annual capex expected to remain in the low double-digit million range (GEL 20-30m).

Higher-than-expected leverage in 2020 with Scope-adjusted debt/EBITDA of 4.0x is the result of the restatement of lease liabilities at YE 2019 of around GEL 10.0m and a foreign exchange loss on USD denominated lease liabilities. Borrowings from banks remained at GEL 47.3m at YE 2020 (GEL 47.5m at YE 2019). Scope’s rating case incorporates leverage gradually returning towards 3.0x (2021E: 3.6x, 2022E: 3.4x, 2023E: 3.2x). Deleveraging should be driven by increasing EBITDA following the company’s sales expansion strategy and the ramp-up of newly opened stores, while indebtedness remains at current levels.

Scope sees liquidity as inadequate. Committed credit lines of GEL 10.6m remained undrawn in 2020 and cash of over GEL 1.0m available on the balance sheet appears insufficient to fully cover (re)-financing needs from expected negative free operating cash flow in 2021-2022 of GEL 10-20m and short-term debt of around GEL 6.0-8.0m. The repayment of bond obligations in August 2021 via bridge loans increased short-term debt on the balance sheet for 2021. The company is currently in the process of issuing a new bond. However, bridge loans from TBC could be rolled over if the issuance of the new bond is delayed.

While no explicit adjustment for supplementary rating drivers has been made, Scope notes that the flow of information between management and the rating agency was often very slow. Although this has not led to any rating impact so far, it may warrant a downgrade going forward (ESG factor).

One or more key drivers for the credit rating action are considered to ESG factors.

Outlook and rating-change drivers

The Outlook is Stable and reflects Scope’s expectation that Nikora Trade’s Scope-adjusted debt (SaD)/Scope-adjusted EBITDA will gradually improve to below 4.0x and that funds from operations (FFO)/SaD will stay above 15%. It also incorporates the agency’s expectation that the company will continue operating with very limited liquidity due to a heavy investment phase weighing on free operating cash flow generation. Scope does not expect any M&A activity or dividend payments in the short term.

A positive rating action could be the consequence of FFO/SaD and SaD/EBITDA above 30% and below 3x respectively or an improvement in liquidity, all on a sustained basis. This could be achieved if, for instance, the top line grows more strongly, outpacing the forecasted surge in raw materials prices, or the level of inventory shrinkages is decreased. A positive rating action could also be warranted if the company grows in size gaining significant market shares outside of Tbilisi area.

A negative rating action could result from a deterioration in credit metrics as indicated by FFO/SaD falling below 15% or SaD/EBITDA increasing above 4.0x on a sustained basis. Such weak financial performance could be triggered by greater competition on the market, putting operating profitability under pressure.

Long-term debt rating

Scope has affirmed the senior unsecured debt at BB- reflecting Scope’s expectations about an above-average recovery for senior unsecured debt positions in the hypothetical event of a company default. The recovery analysis is based on a hypothetical default scenario in 2023, which assumes outstanding senior secured loans, committed credit lines and intercompany guarantees ranked prior to senior unsecured debt category.

While Nikora Trade’s 2020 annual report states that assets (account receivables and inventories) are pledged to senior secured debt, the company has confirmed specific limits on the pledged account receivables and inventories.
 

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

Methodology
The methodologies used for these Credit Ratings and/or Outlook, (Corporate Rating Methodology, 6 July 2021; Rating Methodology: Retail and Wholesale Corporates, 17 March 2021), are available on https://www.scoperatings.com/#!methodology/list.
Scope Ratings GmbH and Scope Ratings UK Limited apply the same methodologies/models and key rating assumptions for their credit rating services, while Scope Hamburg GmbH’s methodologies/models and key rating assumptions are different from those of Scope Ratings GmbH and Scope Ratings UK Limited.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. 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 Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Rated Entity and/or its Related Third Parties participated in the Credit Rating process.
The following substantially material sources of information were used to prepare the Credit Ratings: public domain, the Rated Entity and Scope Ratings' internal sources.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting the Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlook and the principal grounds on which the Credit Ratings and/or Outlook are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlook are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlook are UK-endorsed.
Lead analyst: Zurab Zedelashvili, Senior Analyst
Person responsible for approval of the Credit Ratings: Philipp Wass, Executive Director
The Credit Ratings/Outlook were first released by Scope Ratings on 30 March 2018. The Credit Ratings/Outlook were last updated on 14 September 2020.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures 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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