Thursday 15 January 2015

Tesco gets new junk status credit rating, proving that the 'first cuts were not the deepest...'

Last week's Tesco moves that included shutting 43 stores, moving the head office and ending its pension program, along with the sale of the Blinkbox movie-streaming unit, price cuts and £250m of cost savings, were judged insufficient to prevent S&P downgrading their credit rating from investment grade to junk status.

Following on from Moody's equivalent downgrade last week, it now remains to be seen whether the third major agency, Fitch Ratings, will follow suit.

What is a 'junk bond'?
Junk bonds are fixed-income instruments that carry a rating of 'BB' or lower by Standard & Poor's, or 'Ba' or below by Moody's. As you know, junk bonds are so called because of their higher default risk in relation to investment-grade bonds. In other words, the rating is used by the market to assess the degree of risk for those prepared to engage with a company via purchase of its bonds, investment in its shares, or extending them credit.

In return for the perceived risk, the company will usually have to pay more for the assistance, in terms of interest, or offer earlier payment. This means that the cost of running the business will rise, thereby impacting the bottom line...

What does it mean for Tesco?
Given that the above ratings were given after the announcement of the turnaround plans, it means that the ratings agencies believe that Tesco are not taking sufficient steps to deal with the structural changes in the market, and the discounters in particular...

Action for Tesco?
Tesco now have to add extra moves to the action-list in order to attempt to reverse the junk ratings, ideally before Fitch follow S&P and Moody's.

Possible options include:
  • Extension of the headline 'up to 25%' price-cuts on 380 branded products to perhaps an extra 400 brands to fully replicate Discounter product portfolios
  • Acceleration of asset sales (Tesco Bank, SE Asia interests, perhaps an additional 40+ store closures) in order to pay down debt and reduce the interest burden
  • Searching for, say, an extra £250m in cost savings within the business
NB. the moves have to be sustainable and 'spectacular' in order to counteract the junk ratings, and neutralise the increased costs of doing business.

'Ignoring' the ratings would probably result in additional pressure on the share price.

The Tesco moves also have to be translated into bottom-line KPIs, spelling out how each move will impact net margin, and ROCE, minimum... And all of this in the shadow of the ongoing SFO investigation.

What it means for NAMs?
For speed and clarity, Tesco have to shift the emphasis from back to front margin in order to impact the consumer-shopper.

In order to avoid much of their trade investment ending up in front margin buckets, NAMs need to reassess their competitive appeal relative to other brands/products available to the consumer, in terms of Product, Price, Presentation and Place.

A couple of 'what-ifs' re the impact of a 25% price cut on their brand - or a competitor - in terms of  relative competitive appeal within the category, might help in kick-starting colleagues' focus on the issue...

Next, each element of the investment package should be re-assessed in terms cost to the business and value to the customer, in order to help Tesco to see and quantify the link between brand investment and bottom line impact...

Anything less may be seen as simply another potential cost-saving in a transactional relationship... 

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