UK FOOD RETAILER CREDIT RATING DOWNGRADED

Moody’s Investors Service (“Moody’s”) has today downgraded the corporate family rating (CFR) and the probability of default rating (PDR) of Market Holdco 3 Limited, a holding company formed to effect the acquisition of Wm Morrison Supermarkets Limited (Morrisons), to B2 from B1 and to B2-PD from B1-PD respectively.

At the same time, Moody’s has downgraded Morrisons’ backed senior unsecured MTN programme rating to (P)B2 from (P)B1 and affirmed the (P)NP backed other short-term MTN programme rating. The rating agency has also downgraded to B2 from B1 the ratings of the following existing debt instruments: 1) the backed senior unsecured ratings of all the bonds issued under the programme by Wm Morrison Supermarkets Limited, 2) the backed senior secured bank credit facilities issued by Market Bidco Limited, and 3) the backed senior secured notes issued by Market Bidco Finco Plc. The £1.2 billion privately placed backed senior unsecured notes issued by Market Parent Finco Plc were downgraded to Caa1 from B3. Around £83 million of the bonds issued under the MTN programme remain outstanding following the completion of a tender offer previously launched by Clayton Dubilier & Rice, LLC (CD&R). The outlook on all ratings has changed to negative from stable.

The downgrade of Morrisons’ CFR to B2 from B1 was triggered by the company’s operating underperformance in fiscal 2022, ended 30 October and the resultant weak credit metrics. Leverage, measured in terms of Moody’s adjusted gross debt to EBITDA, stood at 9.1x on 30 October 2022. Moody’s also anticipates that over the next 12-18 months, although improving from recent levels, leverage will remain significantly above the agency’s expectation of leverage below 6.5x for the B1 rating previously assigned.

A full list of affected ratings can be found at the end of this press release.

RATING RATIONALE

The B2 CFR of Morrisons reflects its entrenched market position in the stable, albeit competitive, UK grocery sector, its relatively greater exposure to stable food sales compared to peers, and its experienced management team. It also considers the company’s relatively smaller scale and greater loss of market share to the discounters during the first half of fiscal 2022 compared to the other three “Big Four” UK grocers.

The company’s operating performance during fiscal 2022 was negatively impacted by lower sales (-4.2% like-for-like year on year excluding fuel) and higher input costs – including commodities, energy, wages and transportation, only partly offset by higher fuel margins and cost savings, resulting in lower profit and free cash flow generation compared to fiscal 2021 and Moody’s prior expectations.

The decline in Morrisons’ sales has slowed down in the last quarter of fiscal 2022 (-2.0% like-for-like excluding fuel) and its market share has stabilised, according to Kantar Worldpanel’s publicly available information, and the important three week period up to Christmas saw sales increase by 2.5%. Both trends suggest greater stability of the company’s sales going into fiscal 2023, leading to a recovery of profits through operating leverage, pass-through of higher input costs, and achievement of synergies and efficiencies.

In terms of profitability, Moody’s base case assumes underlying operating margins of 1.5% and 1.7% and absolute underlying operating profit of around £290 million and £340 million in the next two fiscal years respectively. This compares with Moody’s-adjusted underlying operating profit of £240 million in fiscal 2022, for a related margin of 1.3%.

Leverage, measured in terms of Moody’s-adjusted gross debt to EBITDA, stood at 9.1x at the end of fiscal 2022, based on Moody’s-adjusted gross debt of £7.5 billion and Moody’s-adjusted EBITDA of £828 million. Moody’s-adjusted EBITDA includes addbacks of £92 million (transaction costs) related to the acquisition of McColl’s Retail Group (McColl’s) and £105 million (impairments and provisions), which are non-recurring. Moody’s currently expects leverage to reduce to around 8x and 7.5x in fiscal 2023 and 2024, respectively, from low-to-mid single-digit percentage sales growth driven by exposure to the convenience channel and fuel sales.

The expected reduction in leverage will be driven by EBITDA growth and a reduction in gross debt through the repayment of the drawn revolving credit facility. Moody’s currently anticipates EBITDA (on a Moody’s adjusted basis) of around £875 million and £925 million in fiscal 2023 and 2024, respectively. Profit growth over the next two years will be hampered by restructuring and other exceptional costs, relating to the integration of McColl’s and the implementation of the synergy and efficiency programme, that Moody’s does not adjust for and models at £40-45 million per annum. Free cash flow is expected to be positive in each of the next two fiscal years, amounting to 1.5%-3.0% of Moody’s-adjusted debt.

Morrisons’ ESG Credit Impact Score is highly negative (CIS-4). This reflects Moody’s assessment that ESG attributes are overall considered to have a high impact on the current rating driven by high governance risk exposures including an aggressive financial strategy, high leverage, and its majority private equity ownership. As a grocer, Morrisons has moderate environmental and social risk exposures mainly owing to carbon transition and customer relations risks.

LIQUIDITY

Moody’s considers Morrisons’ liquidity profile to be adequate, with £287 million of cash on the balance sheet and £470 million available under its £1,000 million backed senior secured revolving credit facility (RCF) as of the end of October 2022. Morrisons’ substantial portfolio of freehold properties can constitute an alternate source of liquidity through sale-and-leaseback transactions, subject to the limits of its secured debt arrangements.

STRUCTURAL CONSIDERATIONS

The outstanding senior secured debt is rated at the same level as the CFR. This reflects the relatively limited amount of unsecured debt below it in the capital structure, the high leverage before the subordinated debt, a large trade creditors balance, and the overall weak positioning of the rating in the B2 rating category. The unsecured debt is rated two notches below the CFR reflecting their subordination in the company’s capital structure.

OUTLOOK

The negative outlook reflects Moody’s expectation that Morrisons’ debt metrics (on a Moody’s adjusted basis) could remain weak for the B2 rating, although improving from current levels.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

Although unlikely at this stage, the ratings could be upgraded if Moody’s-adjusted leverage reduces sustainably below 6x, with a clear financial policy in line with lower leverage. An upgrade would also require interest coverage on a Moody’s adjusted basis – calculated both in terms of EBIT to Interest expenses and in terms of Cash from Operations (CFO) to (Interest expenses plus capital spending) ? improving towards 2x, free cash flow to debt in mid single-digits in percentage terms and at least adequate liquidity.

The ratings could be downgraded if (i) leverage fails to reduce towards 7x on a Moody’s-adjusted basis over the next 12-18 months, or (ii) if interest coverage ratios (as defined above) fail to improve towards 1.5x, or (iii) if the company generates negative free cash flows (also on a Moodys adjusted basis). A downgrade could ensue also in case the company fails to maintain at least adequate liquidity.

LIST OF AFFECTED RATINGS

Downgrades:

..Issuer: Market Bidco Finco Plc

….BACKED Senior Secured Regular Bond/Debenture, Downgraded to B2 from B1

..Issuer: Market Bidco Limited

….BACKED Senior Secured Bank Credit Facility, Downgraded to B2 from B1

..Issuer: Market Holdco 3 Limited

….Probability of Default Rating, Downgraded to B2-PD from B1-PD

….LT Corporate Family Rating, Downgraded to B2 from B1

..Issuer: Market Parent Finco Plc

….BACKED Senior Unsecured Regular Bond/Debenture, Downgraded to Caa1 from B3

..Issuer: Wm Morrison Supermarkets Limited

….BACKED Senior Unsecured MTN Program, Downgraded to (P)B2 from (P)B1

….BACKED Senior Unsecured Regular Bond/Debenture, Downgraded to B2 from B1

Affirmations:

..Issuer: Wm Morrison Supermarkets Limited

….BACKED Other Short Term, Affirmed (P)NP

Outlook Actions:

..Issuer: Market Bidco Finco Plc