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28 May 2004
MOODY'S LOWERS TO A3/Prime-2 BOOTS' SENIOR UNSECURED RATINGS; OUTLOOK STABLE
Approximately GBP 300 Million of long-term debt affected
London, 28 May 2004 -- Moody's Investors Service lowered the senior unsecured ratings of Boots
Group PLC (Boots) to A3/Prime-2, from A1/Prime-1,
following its recent preliminary results announcement, which also
outlined plans for a share buyback of up to GBP700 million over two years.
The outlook is stable. The ratings lowered are as follows:
Boots Group PLC -- long and short-term senior unsecured debt
ratings to A3/Prime-2, from A1/Prime-1
Moody's said that the two notch downgrade reflects the costs and
challenges for the group in implementing the planned operational improvements
in its core Health and Beauty business, combined with the reduction
in financial flexibility implied by the share buyback programme.
In Moody's view, the group's plans to increase revenue
and capital expenditure, which are designed to underpin market position
and profitability in the medium-term, will constrain cash
flow generation as well as carry significant implementation risk associated
with investment on this scale. The pressure exerted on Boots'
traditionally high margins and market shares in an increasingly competitive
UK non-food retail environment was also a factor in lowering the
rating, the rating agency added.
More positively, Moody's said that the A3 rating reflects
a clearer strategic emphasis on the group's core businesses,
Boots the Chemist (BTC) and Boots Healthcare International (BHI),
which should reduce the risks of value destroying diversification investment.
The rating recognises (i) BTC's strong brand equity, also
reflected on the leading shares it holds in most of the sectors in which
it operates; and (ii) the positive contribution to margins and market
position from BTC's own label range. Finally, the diversification
of business risk (over 9% of sales), represented by BHI's
growth and improving profitability is also factored into the rating.
This rating action concludes the review initiated in March, Moody's
Moody's said that Boots' credit strength continues to be based
on the franchise and market position of BTC, which generated 84%
of group turnover in 2003/4, and GBP531 million of pre-tax
profit. Leading shares (in excess of 20%) across most of
the Health and Beauty segments in which it operates, underpin gross
margins of well over 40%. However, BTC's profitability
and market position are increasingly challenged by a combination of intense
competition, for example from the supermarkets in toiletries,
and an underinvested store base. In 2003/4, on the back of
3.9% like-for-like sales growth, operating
profitability declined to 11.9% from 13.3%
in the year earlier, in part because of the remedial investment
already undertaken in that year.
In order to address these challenges, Moody's noted that Boots
has allocated revenue investment in 2004/5 of GBP90 million to the modernisation
of its offer -- through better service and more newer stores;
as well as GBP50 million to improving the group's efficiency,
both through better logistics and a leaner overhead structure.
The group is also to invest a further 50 basis points (in addition to
the 60 basis points' cost of the existing offer) extending its Lower
Prices You'll Love campaign to more key lines, especially
in toiletries. The rating agency said that increased group capital
spending, up to a medium-term group average of 250 million
annually, will help address the legacy of several years of underinvestment
in the 1,400 store estate, as well as shifting the mix from
smaller to larger stores.
Management's initiatives should help to underpin BTC's position
in the medium-term, and Moody's notes that there have
been some early encouraging indications of progress -- both in terms
of sales volumes and costs. However, in Moody's view
the range and number of initiatives undertaken imply a significant degree
of implementation risk. And against the background of an annualised
110 basis point investment in Lower Prices You'll Love in 2004/5,
there remains some uncertainty on when and at what level gross margin
will stabilise. These risks, and the lower operating margin
and cash flow generation implied by increased investment levels in the
meantime, were important factors in lowering the rating, Moody's
In addition, Moody's considers that the group's plans
to return up to GBP700 million to shareholders over two years will absorb
a significant amount of financial flexibility, during a period of
heightened business risk. Moody's notes the Company's
stated intent to maintain a strong balance sheet, and that payment
of the second tranche of GBP350 million in 2005/6 will depend on the performance
of the business and its generation of net cash flow. Nevertheless,
given that any free cash flow generation in 2004/5 is expected to be limited,
the outlook is for on balance sheet debt to increase materially over the
next year from the net GBP149 million reported at end-March 2004.
Annual operating lease payments will also remain substantial, estimated
in excess of GBP200 million. As a result, Moody's considers
the outlook is for the group's lease adjusted leverage, coverage
and retained cash flow metrics to remain at the low end of what is more
usually seen at the A3 rating level.
Moody's considers that the challenges of implementing successfully
on all strategic initiatives, together with the planned share buybacks,
leave Boots weakly positioned at the A3 level. The stable outlook
assumes, nevertheless, that Boots should be able to deliver
sufficient operational progress, and generate the financial flexibility
required to accommodate its planned share repurchases. Moody's
cautioned, however, that to the extent that the group's
operating performance were to remain unresponsive to the investments being
made, such that cash flow generation were to fall short of planned
returns, then negative rating pressure would likely develop.
Headquartered in Nottingham, England, Boots plc is the UK's
leading Health and Beauty retail group, and generated revenues of
GBP 5.3 billion during the year to March 2004.
Eric de Bodard
Moody's France S.A.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454
Senior Vice President
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454
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