Fitch Ratings has revised WD FF Limited's (Iceland; previously Lannis Ltd) Outlook to Stable from Negative, while affirming the food retailer's Long-Term Issuer Default Rating (IDR) at 'B'.
Fitch also affirmed the senior secured instruments issued by Iceland Bondco plc at 'B+' with a Recovery Rating of 'RR3'.
The revision of the Outlook reflects an uplift in expected earnings from savings and more clarity on energy costs leading to forecast 6.5x EBITDAR gross leverage in the financial year ending March 2024 (FY24). Iceland is exposed to refinancing risk, which will increase as the maturity of the GBP550 million notes nears, and this will weigh on the rating if not addressed 12-15 months ahead of maturity in March 2025.
The 'B' rating also reflects Iceland's specialist business model focused on the frozen food and value-seeking consumer segments, which have been resilient through business cycles. Fitch believes this segment will continue benefiting from the current environment.
Key Rating Drivers
Uplift in Forecast: We have revised our forecast for FY24 EBITDA up to around GBP150 million (after Fitch's GBP15 million deduction for leases). This is due to continued sales growth, benefiting from Iceland's value positioning, disposal of the loss-making business in Ireland (GBP9.2 million loss in FY23), and savings that have more than offset cost inflation. Our forecast of around GBP40 million EBITDA uplift on FY23 prudently builds in some pressure on margin versus the guided GBP50 million reduction from locked-in energy cost in FY24.
High But Improved Leverage: Fitch expects FY24 EBITDAR gross leverage at 6.5x on the back of higher earnings. Leverage remains high for a food retailer, but it is 0.8x improvement against our previous forecast, supporting the Stable Outlook. We expect the company to build headroom under its leverage sensitivities. We also expect coverage metrics will remain weak amid the debt level and higher interest rate environment as Iceland faces refinancing ahead of its March 2025 maturities.
Profit Pressures Managed: We expect Iceland to continue to benefit from various cost-saving measures to help offset cost inflation. Iceland outperformed our rating case in FY23 due to cost savings and disposal of loss-making business in Ireland. Generally, cost inflation is harder to absorb for smaller-scale grocers such as Iceland that operate with thinner EBITDA margins (2.9% in FY23) than large and more diversified mainstream grocers (around 5%-6%). Energy costs are over 95% locked in for FY24, and we build in a further GBP15 million reduction in costs on the back of current market prices, but this is yet to be locked in.
Cash Generative Business: Similar to other food retailers, Iceland is a cash-generative business. We expect a neutral to positive free cash flow (FCF) margin, trending towards 1% in FY26, which is broadly aligned with peers, and is reflected in the Stable Outlook. This is after GBP40-55 million capex, of which only GBP15 million is maintenance, and higher interest costs.
Limited Outflows From Restricted Group: Our rating case does not capture any further material outflows to support, or any dividends from its restaurant business as its trading recovers. The company has guided about its intentions to reduce its GBP800 million debt instead. Iceland has invested nearly GBP50 million in its non-core restaurant business, which remains outside the restricted group. Iceland initially up-streamed GBP31 million (3Q21), subsequently funded its trading losses and repaid its GBP15 million bank loan during FY23-24.
Value Positioning Benefits: Consumer focus on value amid living cost pressures puts Iceland in a good position to gain market share or at least hold on to it. Iceland is UK's second-largest frozen food retailer after Tesco.
Iceland grew its sales during the global financial crisis and slightly increased its share in the UK grocery market between 2008 and 2023, despite competitive pressures and the rapid growth of discount stores. This was achieved by greater differentiation in its product offering, improved pricing, investment in its stores and formats, and improved brand positioning with regard to the environment and sustainability. We expect the UK food industry to continue to have stiff competition.
Derivation Summary
Iceland's business risk profile, as a mostly UK-based specialist food retailer, is constrained by the company's modest size and lower diversification compared to other Fitch-rated European food retailers, such as Tesco Plc (BBB-/Stable) and Bellis Finco Plc (ASDA; B+/Stable) and Market Holdco 3 Ltd (Morrisons; B+/Stable). All three peers have higher market share, larger scale, and greater diversification than Iceland.
We expect Iceland's EBITDAR leverage to reduce to 6.5x in FY24 from 7.6x in FY23, which is higher than Fitch-rated UK peers (Morrisons: from around 7.0x in FYE23 (year-end October) to 6.3x by FYE24; ASDA: from around 6.0x for 2023 to 5.0x by end-2024, Tesco around 3.5x), which also benefit from stronger coverage ratios.
Iceland is larger than Picard Bondco S.A. (B/Negative), a French specialist food retailer also active in frozen foods, but its profitability is materially weaker (EBITDAR margin of 6% versus Picard's 17%). Picard operates mostly in the higher-margin premium segment and benefits from strong brand awareness. Picard's financial leverage is currently similar to Iceland's on an EBITDAR gross leverage basis. We expect it to remain above 7.0x in FY23-FY25, but it has better deleveraging capability and a stronger business profile.
Key Assumptions
Fitch's Key Assumptions Within its Rating Case for the Issuer:
Retail revenue (excluding restaurants) growth of 4.0% in FY24 driven by consumer focus on value, Food Warehouse store openings offset by core Iceland store closures. Growth of about 1.0%-1.6% thereafter.
Four Food Warehouse openings in FY24, increasing to 20-25 stores per year in the following years, partly offset by core Iceland store closures of 10-20 per year.
EBITDA margin to recover to 3.7% in FY24 and 4% thereafter, driven by cost-saving initiatives helping more than offset wage inflation and some normalisation in energy cost.
Working capital outflow of GBP16 million in FY24 and neutral thereafter.
Capex of GBP40 million in FY24 in line with management's guidance, increasing to GBP55 million to fund Warrington depot in FY25 and then reverting to GBP40-50 million thereafter.
Refinancing of GBP550 million senior secured notes ahead of maturity in March 2025
No dividends or other distributions over the rating horizon; FY24 includes the repayment of bank loan (GBP12.5 million) borrowed by restaurant business.
Fitch's Key Recovery Rating Assumptions:
Fitch's recovery analysis assumes that Iceland would be reorganised as a going-concern in bankruptcy scenario rather than liquidated.
We have assumed a 10% administrative claim.
Iceland's going-concern EBITDA assumption reflects the scale of the company's business with new stores openings each year, improved cost base with visibility on energy cost and disposed loss making business in Ireland. We have excluded the restaurant business from our going-concern EBITDA calculation as the lenders under the rated debt instruments have no recourse to these cash flows.
The going-concern EBITDA estimate of GBP120 million (GBP110 million previously) reflects our view of a sustainable, post-reorganisation EBITDA, upon which we base the enterprise valuation (EV), and excluding the loss-making Irish operations following their disposal. The assumption also reflects corrective measures taken in the reorganisation to offset the adverse conditions that trigger its default, such as cost-cutting efforts or a material business repositioning.
We apply an EV multiple of 4.5x (unchanged) to the going-concern EBITDA to calculate a post-reorganisation EV.
Iceland's RCF, which has increased to GBP50 million (from GBP20 million) is assumed to be fully drawn upon default. The RCF is super-senior to the company's senior notes in the debt waterfall.
The allocation of value in the debt waterfall results in recovery expectations corresponding to a 'RR3' Recovery Rating for the existing GBP800 million rated notes, with a recovery percentage of 55% (53% previously).
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to an upgrade(to B+):
We view an upgrade of the IDR as unlikely over the next two years, unless Iceland adopts and follows a more conservative financial policy.
Evidence of positive and profitable like-for-like sales growth and the maintenance of stable market shares, leading to resilient profitability with EBITDA margins increasing towards 5%, could lead to positive rating action.
Total EBITDAR leverage below 5.5x on a sustained basis.
EBITDAR fixed-charge coverage above 2.0x on a sustained basis.
Factors that could, individually or collectively, lead to negative rating action/downgrade(to B-):
Absence of advanced refinancing in the 12-15 months before the major contractual maturity (March 2025)
Evidence of negative like-for-like sales growth, with loss of market shares due to a competitive environment or to permanently lower capex, or inability to pass on or to mitigate cost inflation, leading to a prolonged and accelerating EBITDA margin erosion or neutral FCF.
Tightening of liquidity amid unexpected cash outflows.
EBITDAR leverage above 6.5x on a sustained basis.
EBITDAR fixed-charge coverage below 1.5x on a sustained basis.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Comfortable Liquidity: Fitch views Iceland's current liquidity as comfortable, comprising around GBP139 million at FYE23, which excludes restricted GBP20 million for working-capital purposes (Fitch's adjustment) along with an around GBP46 million undrawn RCF (maturing in February 2025). Iceland has used GBP12.5 million to repay debt borrowed by the restaurant business after FYE23.
Refinancing risk on the upcoming GBP550 million senior secured notes maturing in March 2025 has increased and will weigh on the rating if not addressed 12-15 months ahead of maturities.
Issuer Profile
Iceland is a British food retailer specialising in frozen and chilled food products at a low price point. It operates around 1,000 stores in the UK.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
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