Fitch Revises O'key's Outlook to Positive; Affirms at 'B+'

(The following statement was released by the rating agency)

LONDON/MOSCOW, December 18 (Fitch) Fitch Ratings has revised Russia-based food

retailer O'key Group S.A.'s (O'key) Outlook to Positive from Stable. Its foreign

and local currency Long-term Issuer Default Ratings (IDRs) have been affirmed at

'B+'. Fitch has also affirmed LLC O'key's senior unsecured debt at 'B+' with a

Recovery Rating of 'RR4'. The National Long-term rating has been upgraded to

'A(rus)' from 'A-(rus)'.

The revision in the Outlook to Positive reflects O'key's improving operating

performance leading to better-than-expected credit metrics for the next three

years. It also reflects Fitch's confidence in management's ability to deliver on

its growth plans while maintaining fairly stable credit metrics. Fitch expects

O'key will continue to grow and achieve EBITDAR of near EUR500m by 2015 which,

together with greater format diversification and an enlarged geographic

footprint, will be more commensurate with a higher rating. Although O'key's

credit metrics are currently consistent with a higher rating - in the 'BB'

category - they are offset by its modest size and systemic corporate governance

risks stemming from operating in Russia.

KEY RATING DRIVERS

High Profitability but Constrained by Size

The ratings reflect O'key's strong position in the growing hypermarket food

retail segment in Russia, its high profit margins and a growing presence across

Russia's regions (48% of sales in St. Petersburg expected in 2013 vs. 59% in

2010). This is balanced with the group's moderate size in terms of EBITDAR and

market position (sixth largest) compared with other domestic and international

leading food retailers in Russia.

Better-than-expected Credit Metrics

FY12 reflected better-than-expected credit metrics owing to lower capex. In

FY12, funds from operations (FFO)-adjusted net leverage was 2.7x compared with

Fitch's expectation of above 3x. FFO fixed charge cover was 2.9x. Given a

smaller than expected capex programme and to reflect the current trading

environment, we expect FFO-adjusted net leverage to remain within 3.0x-3.3x by

2015. Similarly, FFO fixed charge cover is expected to remain above 2.8x, which

is strong for the ratings.

Negative Free Cash Flow

We project that O'key will be able to finance more than 80% of its capex needs

with internally generated cash flows. O'key is, however, expected to show

negative free cash flow (FCF) over the next four years averaging 2% of net sales

per annum due to its large expansion programme and a dividend payout of up to

25% of group's net profit. This is mitigated by O'key's proven access to both

bank and capital markets and its ability to obtain trade creditors' financing

for its working capital as sales continue to grow at a solid pace.

Key Russian Hypermarket Operator

The group's positioning in the fast-growing hypermarket format enables O'key to

capture the structural shift towards modern food retail chains in Russia. Fitch

notes that the group has been resilient during the 2008/9 economic downturn. In

addition, the group's operating performance in terms of sales per sq m compares

positively against other food retailers: RUB312,000 for O'key vs. RUB268,000 for

X5 Retail Group and RUB 292,000 for Lenta in FY12.

Tougher Retail Competition in Russia

O'key will face more intense competition from major market players, who have

also aggressive expansion plans and have targeted hypermarkets as one of their

areas of growth. Additionally as pricing remains the major factor for Russian

customers, further expansion from competitors will translate into pressure on

retailers' operating margins especially if the Russian consumer environment

remains subdued next year.

Although O'key has been successful in one of the most competitive regions in

Russian (St. Petersburg - 51% of group sales in 2012), there are execution risks

embedded in O'key's expansion plans into Moscow and other main regions in Russia

where consumer purchasing power and infrastructure are less developed compared

with its core St. Petersburg's market. However, we expect that the group's

expansion will enable O'key to reinforce its purchasing power over suppliers.

Further Expansion and Growth in Scale

O'key plans to increase its selling space annually by 20%, mostly on the back of

organic expansion in its core hypermarket format, continued development of its

supermarket format and the launch of a new discounter format. O'key plans to

open its first 100 smaller stores around 2015-16 in the Moscow region. This

should result in significant growth in scale with EBITDAR projected to exceed

EUR550m by 2016. Fitch will consider this factor positively for the ratings

provided that management remains disciplined in its expansion strategy and

maintains strong profit margins, robust cash flow from operations (after changes

in working capital) and conservative credit metrics.

Adequate Liquidity

At end-September 2013 about 90% of O'key's debt was long-term (RUB15bn) and all

of short-term debt maturities were revolving credit facilities. In addition,

O'key registered a new bond programme with a total value of RUB25bn including

six tranches (RUB3bn-5bn) of five-year maturity. In October 2013, O'key placed a

tranche of RUB5bn. Combined with strong operating cash flow expected in FY13-14

we believe that liquidity sources are sufficient both for debt servicing and for

financing O'key's expansion plans. Adequate liquidity is supported by available

cash of RUB2.5bn as of end-June 2013 and RUB7.9bn of undrawn credit facilities

as of end-September 2013.

Corporate Governance Risks

While O'key's corporate governance is considered by Fitch to be above average

relative to other Russian corporates, this is still insufficient to justify a

higher rating given the lack of independence on its Board of Directors.

RATING SENSITIVITIES

Positive: Future developments that could lead to a positive rating action

include:-

- Solid execution of its expansion plan and positive like-for-like sales growth

- Group's size expanding to at least EUR500m in EBITDAR by 2016

- Ability to maintain the group's EBITDAR margin of at least 9.5%-10%.

- FFO-adjusted net leverage below 3x (or the equivalent of lease adjusted net

debt/EBITDAR to below 2.5x) on a sustained basis

- FFO fixed charge coverage above 3x on as sustained basis

Negative: Future developments that could lead to a negative rating action

including but not limited to the Outlook being revised to Stable, include:

- A sharp contraction relative to close peers in like-for-like sales growth

- EBITDAR margin erosion to below 9%

- FFO-adjusted net leverage remaining above 4x (or the equivalent of lease

adjusted net debt/EBITDAR to above 3.5x) on a sustained basis

Contact:

Principal Analyst

Tatiana Bobrovskaya

Associate Director

+7 495 956 5569

Supervisory Analyst

Ching Mei Chia

Director

+44 20 3530 1068

Fitch Ratings Limited

30 North Colonnade

London E14 5GN

Committee Chair

Pablo Mazzini

Senior Director

+44 20 3530 1021

Media Relations: Julia Belskaya von Tell, Moscow, Tel: +7 495 956 9908, Email:

[email protected]; Peter Fitzpatrick, London, Tel: +44 20

3530 1103, Email: [email protected].

Additional information is available on www.fitchratings.com. For regulatory

purposes in various jurisdictions, the supervisory analyst named above is deemed

to be the primary analyst for this issuer; the principal analyst is deemed to be

the secondary.

Applicable criteria, 'Corporate Rating Methodology', dated 5 August 2013, are

available at www.fitchratings.com.

Applicable Criteria and Related Research:

Corporate Rating Methodology: Including Short-Term Ratings and Parent and

Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139

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(Repeat for additional subscribers)

Dec 18 (Reuters) - (The following statement was released by the rating agency)

Fitch Ratings has revised Russia-based food

retailer O'key Group S.A.'s (O'key) Outlook to Positive from Stable. Its foreign

and local currency Long-term Issuer Default Ratings (IDRs) have been affirmed at

'B+'. Fitch has also affirmed LLC O'key's senior unsecured debt at 'B+' with a

Recovery Rating of 'RR4'. The National Long-term rating has been upgraded to

'A(rus)' from 'A-(rus)'.

The revision in the Outlook to Positive reflects O'key's improving operating

performance leading to better-than-expected credit metrics for the next three

years. It also reflects Fitch's confidence in management's ability to deliver on

its growth plans while maintaining fairly stable credit metrics. Fitch expects

O'key will continue to grow and achieve EBITDAR of near EUR500m by 2015 which,

together with greater format diversification and an enlarged geographic

footprint, will be more commensurate with a higher rating. Although O'key's

credit metrics are currently consistent with a higher rating - in the 'BB'

category - they are offset by its modest size and systemic corporate governance

risks stemming from operating in Russia.

KEY RATING DRIVERS

High Profitability but Constrained by Size

The ratings reflect O'key's strong position in the growing hypermarket food

retail segment in Russia, its high profit margins and a growing presence across

Russia's regions (48% of sales in St. Petersburg expected in 2013 vs. 59% in

2010). This is balanced with the group's moderate size in terms of EBITDAR and

market position (sixth largest) compared with other domestic and international

leading food retailers in Russia.

Better-than-expected Credit Metrics

FY12 reflected better-than-expected credit metrics owing to lower capex. In

FY12, funds from operations (FFO)-adjusted net leverage was 2.7x compared with

Fitch's expectation of above 3x. FFO fixed charge cover was 2.9x. Given a

smaller than expected capex programme and to reflect the current trading

environment, we expect FFO-adjusted net leverage to remain within 3.0x-3.3x by

2015. Similarly, FFO fixed charge cover is expected to remain above 2.8x, which

is strong for the ratings.

Negative Free Cash Flow

We project that O'key will be able to finance more than 80% of its capex needs

with internally generated cash flows. O'key is, however, expected to show

negative free cash flow (FCF) over the next four years averaging 2% of net sales

per annum due to its large expansion programme and a dividend payout of up to

25% of group's net profit. This is mitigated by O'key's proven access to both

bank and capital markets and its ability to obtain trade creditors' financing

for its working capital as sales continue to grow at a solid pace.

Key Russian Hypermarket Operator

The group's positioning in the fast-growing hypermarket format enables O'key to

capture the structural shift towards modern food retail chains in Russia. Fitch

notes that the group has been resilient during the 2008/9 economic downturn. In

addition, the group's operating performance in terms of sales per sq m compares

positively against other food retailers: RUB312,000 for O'key vs. RUB268,000 for

X5 Retail Group and RUB 292,000 for Lenta in FY12.

Tougher Retail Competition in Russia

O'key will face more intense competition from major market players, who have

also aggressive expansion plans and have targeted hypermarkets as one of their

areas of growth. Additionally as pricing remains the major factor for Russian

customers, further expansion from competitors will translate into pressure on

retailers' operating margins especially if the Russian consumer environment

remains subdued next year.

Although O'key has been successful in one of the most competitive regions in

Russian (St. Petersburg - 51% of group sales in 2012), there are execution risks

embedded in O'key's expansion plans into Moscow and other main regions in Russia

where consumer purchasing power and infrastructure are less developed compared

with its core St. Petersburg's market. However, we expect that the group's

expansion will enable O'key to reinforce its purchasing power over suppliers.

Further Expansion and Growth in Scale

O'key plans to increase its selling space annually by 20%, mostly on the back of

organic expansion in its core hypermarket format, continued development of its

supermarket format and the launch of a new discounter format. O'key plans to

open its first 100 smaller stores around 2015-16 in the Moscow region. This

should result in significant growth in scale with EBITDAR projected to exceed

EUR550m by 2016. Fitch will consider this factor positively for the ratings

provided that management remains disciplined in its expansion strategy and

maintains strong profit margins, robust cash flow from operations (after changes

in working capital) and conservative credit metrics.

Adequate Liquidity

At end-September 2013 about 90% of O'key's debt was long-term (RUB15bn) and all

of short-term debt maturities were revolving credit facilities. In addition,

O'key registered a new bond programme with a total value of RUB25bn including

six tranches (RUB3bn-5bn) of five-year maturity. In October 2013, O'key placed a

tranche of RUB5bn. Combined with strong operating cash flow expected in FY13-14

we believe that liquidity sources are sufficient both for debt servicing and for

financing O'key's expansion plans. Adequate liquidity is supported by available

cash of RUB2.5bn as of end-June 2013 and RUB7.9bn of undrawn credit facilities

as of end-September 2013.

Corporate Governance Risks

While O'key's corporate governance is considered by Fitch to be above average

relative to other Russian corporates, this is still insufficient to justify a

higher rating given the lack of independence on its Board of Directors.

RATING SENSITIVITIES

Positive: Future developments that could lead to a positive rating action

include:-

- Solid execution of its expansion plan and positive like-for-like sales growth

- Group's size expanding to at least EUR500m in EBITDAR by 2016

- Ability to maintain the group's EBITDAR margin of at least 9.5%-10%.

- FFO-adjusted net leverage below 3x (or the equivalent of lease adjusted net

debt/EBITDAR to below 2.5x) on a sustained basis

- FFO fixed charge coverage above 3x on as sustained basis

Negative: Future developments that could lead to a negative rating action

including but not limited to the Outlook being revised to Stable, include:

- A sharp contraction relative to close peers in like-for-like sales growth

- EBITDAR margin erosion to below 9%

- FFO-adjusted net leverage remaining above 4x (or the equivalent of lease

adjusted net debt/EBITDAR to above 3.5x) on a sustained basis

Keywords: Fitch Revises O'key's Outlook to Positive; Affirms

(Bangalore Ratings Team, Hotline: +91 80 6677 2513 [email protected], Group id: [email protected], Reuters Messaging: [email protected])

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