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Rating Action:

MOODY'S ASSIGNS A Ba3 RATING TO HORNBACH BAUMARKT AG SENIOR NOTES ISSUE; SENIOR IMPLIED RATING AT Ba2; OUTLOOK STABLE

08 Nov 2004
MOODY'S ASSIGNS A Ba3 RATING TO HORNBACH BAUMARKT AG SENIOR NOTES ISSUE; SENIOR IMPLIED RATING AT Ba2; OUTLOOK STABLE

Approximately Euro 200 million of Long Term Debt Securities Affected

London, 08 November 2004 -- Moody's Investors Service today assigned a Ba2 senior implied rating to Hornbach Baumarkt AG ( 'HB') the principal operating company of the Hornbach Holdings AG ('HH') group.

New ratings assigned to HB are as follows:

- Senior implied rating of Ba2

- Unsecured issuer rating of Ba3

- Euro 200 million of senior guaranteed notes due 2014 rated Ba3

The outlook for all ratings is stable.

SUMMARY RATING RATIONALE

The Ba2 senior implied rating factors in (i) the company's financial metrics which the agency considers weakly positioned for the Ba2 rating category. FYE Feb 2004 saw total coverage at 1.8x and net adjusted debt : EBITDAR at 5.0x. Today's assignment of ratings prospectively assumes that the company's leverage and total coverage measures will migrate towards 4.7x and 2.3x respectively over the next 24 months to position the rating more in line with the rating category (ii) the weak German macro economic environment which is expected to weigh on the retail sector for the foreseeable future (iii) the legacy of over capacity in the German DIY segment (iv) a tough domestic competitive environment and the challenge Hornbach continues to face from its larger rivals such as OBI and Praktiker (v) the execution challenges associated with its international expansion strategy and maintaining tight management control over its growing international network and (vi) The agency's expectation that the company will continue to invest heavily in growing its store network limiting the prospects for free cash-flow generation over the medium term.

More positively the senior implied rating of Ba2 reflects (i) HB's growing scale in the highly competitive German DIY segment (ii) the success of the company's EDLP pricing model and its focus on higher average ticket 'project customers' enabling it to deliver like for like sales growth significantly above the German sector average over recent years (iii) the quality of its stores and real estate locations (iv) its conservative organic growth model (iv) the increasing scale and improving profitability of its international operations (v) the efficiency of the company's supply and distribution infrastructure and (vi) the benefits the company is deriving from its close relationship with Kingfisher plc in particular through the latter's Asian buying group.

The stable outlook reflects Moody's expectation that (i) HB's business model will enable it to continue to deliver like for like sales growth at least in line with the German DIY sector average (ii) that margins in Germany will improve modestly over the intermediate term and (iii) that the company's leverage measures will improve over the intermediate term to position the rating more in line with the Ba2 rating category. The stable outlook also factors in the progressive maturation of the company's international operations and the expectation that earnings from this segment will represent an increasing share of group earnings over time.

An upgrade would require a reduction in indebtedness such that total lease adjusted leverage falls below 4.5x on a sustainable basis with total cover in excess of 2.5 times

Conversely, weakness in the company's core German market, either through sustained weakness in like for like sales and /or margin pressure would be likely to put the rating under downward pressure.

KEY CREDIT RISKS

The Ba2 senior implied rating reflects the financial risks associated with HB's leveraged capital structure. Moody's notes that HB, in common with other retailers, uses operating leases to finance a significant portion of its store estate. Going forward the agency expects HB to use operating leases to finance the growth of its store network. At FYE Feb 2003 around 50% of the company's operating lease rental payments were made to Hornbach Immobilien AG a specialised property development business which is a 100% subsidiary of HH. The balance of HB's operating lease payments were through leasing contracts with third parties. Moody's has factored in the company's Euro 83mm of lease rental payments in the leverage ratios through the capitalisation (at 8x) of the rent payable.

Moody's believes the weak German macro economic environment will continue to weigh on the retail sector and the outlook for HB. The German economy has been in a state of virtual stagnation during the three year period to 2003. With high unemployment (10.7% in Aug from 10.5% in Dec-03, according to Bundesbank data) coupled with a high savings rate and one of the highest rates of overall taxation in Europe, the German retail sector has been continuing to struggle to deliver growth. Although recent economic data confirmed that the German economy was recovering as the capital expenditure cycle, industrial production and manufacturing orders have been responding to improved global economic conditions, the outlook for 2005 is for economic activity to accelerate only marginally to 1.6% from an estimated 1.4% in 2004. Moody's believes that the prospects for the German retail sector will continue to be challenging until there is greater visibility over the pace and strength of the economic recovery. With the DIY sector characterised by fierce competition amongst the main players in the sector and the expectation that the sector will continue to have excess capacity, competition for sales is expected to remain intense. In Moody's view should consumer spending not recover HB's sales growth and margins would likely be constrained.

Moody's notes the greater scale and ownership of HB's largest competitors (OBI , 16.8% market share at Dec 03 , majority owned by Tengelman; Praktiker, 11.1% market share at Dec 03, wholly owned by Metro AG ( rated Baa1 negative outlook )). The agency considers that their superior scale, leverage with suppliers and the financial resources of their shareholders are likely to ensure the German DIY sector remains highly competitive going forward.

KEY CREDIT STRENGTHS

Hornbach's national coverage in Germany through large box 'Megastore' formats combined with price leadership underpins its domestic franchise. Moody's notes that the company has successfully rolled out an EDLP pricing model across its domestic and international store networks which when combined with its price leadership, its focus on 'project customers' and its culture of customer focus have enabled the group to deliver like for like growth in Germany significantly ahead of the sector average on a sustained basis over recent years. With the company's domestic store base more heavily concentrated in the faster growing south / south west regions of Germany, HB has also been able to benefit from the higher consumer demand / retail spend than the country as a whole. Looking ahead Moody's expects the company to continue to expand its network of large box outlets especially in faster growing urban conurbations where it has an existing regional presence and in so doing leverage its supply and distribution infrastructure. Moody's considers the company's domestic growth strategy to be low risk with the company's organic growth model expected to lead to only small numbers of net new store openings annually. Internationally HB's sales have been growing rapidly, albeit from a low base, and on the back of the company's price focused operating model Moody's expects this segment to make a significant contribution to group earnings from FYE Feb 2005. The agency notes that HB's international operations have scale in Austria and The Netherlands with more limited operations in Czech Republic and Switzerland. HB's growth strategy is based upon stores controlled and managed by the group in contrast to franchising which has been used by a number of its competitors such as OBI.

HB's liquidity is considered to be adequate. Its liquidity profile is supported by its access to a panel of dedicated bi-lateral committed bank facilities which currently total Euro100mm. The company's two longest dated committed lines include financial covenants ( EDITDA margin , EBITDA / Interest and Equity / Assets ) with testing to be undertaken semi annually. One facility requires covenant testing on HB and the other on HH. Moody's notes that covenant headroom is considered to be comfortable and expected to improve. The proceeds of the Euro200mm bond issue will be used to repay drawings under its unsecured bank facilities with the balance (c Euro 100mm) expected to be retained within the business to finance the company's store investment programme. Moody's believes that HB will not need to draw under its committed bank lines for up to 12 months from the issue of the bond. The company's debt maturities are well managed with HB having Euro30mm of debt falling due by August 2005 and a further Euro 63mm falling due between September 2005 and August 2006.

STRUCTURAL CONSIDERATIONS

The 2014 notes are issued by HB and benefit from senior guarantees from operating businesses accounting for 82 % of tangible net assets and 100 % of EBITDA. The notes have been assigned a Ba3 rating, ie one notch behind the senior implied reflecting the significant amount of secured mortgage debt ( Euro 298mm at February 2004 ) counterbalanced by (i) the agency's view that the notes will benefit from satisfactory asset coverage and (ii) the agency's understanding that the company plans, over time, to substitute mortgage loans for senior unsecured debt the impact of which is expected to be positive for unsecured bond holders.

Moody's notes that there is a profit and loss agreement in place between HB and its wholly owned subsidiary Hornbach International Gmbh a holding company for HB's International operations. The purpose of the agreement is to support tax efficient pooling of profits and losses at the holding company level. Whilst there is an obligation on HB to cover any accumulated loss ( not covered by reserves ) at Hornbach International, Moody's does not treat such arrangements as a guarantee given (i) they are primarily tax driven (ii) the satisfactory level of reserves held at Hornbach International Gmbh and (iii) the expectation of increasing profits being generated by the group's international businesses. The agency added that it believes that HB will continue to carefully manage the level of reserves at Hornbach International to ensure that they are maintained at prudent levels and enabling it to upstream the annual profits from the international business to HB.

The indenture is considered to provide adequate protection for bond holders from a ring fencing perspective. Although HB is able to provide inter-company loans to affiliates such loans need to be on an 'arms length' basis. In addition inter-company loans in excess of Euro10mm would require an assessment by an independent intermediary of international standing. The indenture permits annual dividend payments in FYE 2005 and FYE 2006 of Euro13.1mm per annum though thereafter dividend payments can step up to 50% of consolidated net income. Moody's assignment of a Ba2 senior implied rating assumes that the company's financial metrics will have strengthened sufficiently such that by the time the relaxation in dividend payments becomes effective the higher dividends, if paid, would not have a material impact on the company's credit profile.

The proposed notes will be sold in a privately negotiated transaction without registration under the United States Securities Act of 1933 ("the Act") under circumstances reasonably designed to preclude a distribution thereof in violation of the Act. The issuance will be designed to permit resale under Rule 144A and Regulation S of the Act.

The assigned ratings assume there will be no material variations to the draft legal documentation reviewed by Moody's and assume that these agreements are legally valid, binding and enforceable.

COMPANY SUMMARY

Hornbach Baumarkt is a leading operator in the German DIY sector with a growing presence in Austria, The Netherlands, Switzerland, Czech Republic, Luxembourg, Sweden and Slovakia. In the financial year ended February 2004 the company recorded sales of Euro 1.9 billion

London
David G. Staples
Managing Director
Corporate Finance Group
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

London
Andrew B. Canwell
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

No Related Data.
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