Tesco CEO shuns more quick fixes to retailer's debt woes

[LONDON] Tesco Plc's plan to cut debt without selling any more major assets is raising questions over the UK supermarket leader's ability to recapture investment-grade status if it doesn't sell shares first.

"They can get there in about four years, but they'd be running a risk that markets could turn down," Rob Orman, a credit analyst at Henderson Global Investors, said by phone. "If they did a rights issue, they could get there in a year or so." Because of price cuts to win back customers, Tesco's UK same-store sales are falling and its operating margins are being squeezed. Yet Chief Executive Officer Dave Lewis has ruled out further major divestments to help the retailer cut its £17.7 billion (US$27 billion) debt burden, following September's £4 billion disposal of its Korean operations. The planned sale of the Dunnhumby data-analytics unit was abandoned this month.

Mr Lewis announced a renewed focus on cash generation last week alongside results that showed Tesco generated £281 million of free cash flow compared with an outflow of £134 million over the same period last year. The reversal was driven by a reduction in capital expenditure, which Tesco has budgeted to be less than half of the £2 billion spent last year.

Balancing the need to cut investment without jeopardizing a recovery in UK profits will be a key challenge for Mr Lewis. Moody's Investors Service has said any return to investment grade will be contingent on a sustainable upturn in UK same- store sales and an improvement in its operating margin to about 3 per cent from 1.1 per cent last year.

Moody's and Standard & Poor's stripped Tesco of its investment grade in January, with Fitch Ratings following in April. All three rate Tesco the highest level of junk. Tesco bonds have lost 0.6 per cent this month, the worst performer among the 50 largest similarly rated issuers of sterling bonds, according to Bank of America Merrill Lynch index data.

In cutting capital expenditure, Tesco may risk ceding ground to competitors. In a note to investors after the company's results, Shore Capital analyst Clive Black said management needs to explain how spending can stay "significantly" below depreciation, while keeping stores competitive.

Tesco moved to ease shareholder concern over the possibility of a rights offering last week. Chief Financial Officer Alan Stewart said the company's £5 billion of undrawn credit facilities meant it had "no issues" from a liquidity perspective. Mr Lewis said "philosophically" he would always look to boost Tesco's performance internally before considering an attempt to raise cash from shareholders, although he declined to rule out the possibility. Investors have gone without a dividend this year, with no indication yet of when the next one will come. The shares have fallen 21 per cent in the last six months, about double the decline in the FTSE 100 Index.

BLOOMBERG