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Rating Action:

Moody's downgrades Hornbach's corporate family rating to Ba3, negative outlook

26 Aug 2019

Paris, August 26, 2019 -- Moody's Investors Service ("Moody's") has today downgraded the long-term corporate family rating (CFR) of Hornbach Baumarkt AG ("Hornbach" or the "company"), the German DIY-store chain, to Ba3 from Ba2. Concurrently Moody's downgraded the company's Probability of Default Rating (PDR) to Ba3-PD from Ba2-PD while it affirmed the Ba2 rating on the EUR250 million worth of senior unsecured notes due in 2020 (the "Bond"). The outlook was changed to negative from stable.

Today's downgrade to Ba3 reflects Hornbach's higher-than-expected gross adjusted debt, which will increase Moody's gross adjusted leverage to around 5.5x in fiscal 2019, substantially higher than the 4.0x Moody's anticipated. Moody's only expects leverage to strengthen towards 5.0x in fiscal 2020. Hornbach's absolute EBITDA generation is forecast by Moody's to improve over the next 12-18 months, but not sufficiently to offset the higher-than-expected gross debt. Hornbach continues to face margin pressures, EBIT/interest is weak at below 2.0x and the company's high capital expenditure continues to put pressure on free cash flow (FCF) due to the company's growth strategy.

The main reasons for the higher-than-expected gross adjusted debt, and increase in leverage to around 5.5x in fiscal 2019 are: (i) the issuance of EUR295 million worth of promissory notes ("promissory notes") in fiscal 2018 and Moody's expectation that the company may need to issue additional debt to finance its growth strategy despite the fact that the company has said the promissory notes are to pre-finance the EUR250 million Bond maturing in February 2020; and (ii) the introduction of IFRS 16, which Moody's expects will to lead to capitalized operating lease liability of EUR1,193 million, around EUR362 million higher than Moody's current operating lease adjustment of EUR831 million.

The Ba2 rating on the Bond is one notch higher than the CFR reflecting that the promissory notes are not guaranteed by Hornbach's operating subsidiaries and therefore subordinated to the Bond.

RATINGS RATIONALE

The downgrade primarily reflects the increase in Hornbach's reported financial debt to EUR762 million in fiscal 2018 from EUR424 million in fiscal 2017 to fund ongoing development capex in new stores, real estate and digitalization projects, which lead to negative free cash flows in fiscal 2018. Despite the maturity of the EUR250 million Bond maturing in February 2020, Moody's expects Hornbach's reported financial debt is likely to remain at a similar level over the next 12 to 18 months in order that the company can finance new store openings and other capital expenditure and at the same time, maintain a cash balance of at least EUR100 million. The increase in financial debt is to some extent compensated by the company's EUR313 million cash balance as of May 2019 and the company's good liquidity especially given the company has evidenced a conservative financial policy to date. Moody's does not expect Hornbach would use cash to make sizeable acquisitions or increase dividend payments.

Hornbach's expected increase in leverage is also driven by the application of IFRS16 accounting standard, which the company estimates would have increased financial debt by EUR1,193 million in fiscal 2018. This amount is around EUR362 million higher than the EUR831 million debt adjustment that Moody's made for the capitalization of operating leases in fiscal 2018. The main reason for this difference is that the previous disclosure of undiscounted future lease payments did not capture certain renewal options of existing lease contracts, which the company has decided are "reasonably certain" to be exercised. When IFRS16 becomes effective in fiscal 2019, Moody's estimates that this will increase Hornbach's Moody's adjusted debt to EBITDA by around 1.0x to around 5.5x. Moody's considers that the adoption of IFRS16 represents material new information that the agency didn't have before.

The downgrade also reflects continued margin erosion in part driven by operating cost increases and partly driven by intense competition in the German DIY market. Moody's Adjusted EBIT margin declined to 2.8% from 3.6% in fiscal 2017, which is lower than historical levels and lower than the 3% Moody's expected. Interest cover (as measured by Moody's Adjusted EBIT to Interest Expense) also deteriorated to 1.8x in fiscal 2019 from 2.4x in fiscal 2018. Moody's expects some recovery in EBITDA over the next 12-18 months as turnover should continue to grow at mid-single digits. This is supported by the company's solid Q1 2019 results, where revenues and EBITDA grew 8.5% and 17% (excluding the impact of IFRS16) despite more challenging macroeconomic conditions. Hornbach also expects to improve its cost base such that margins stabilise. The EBITDA increase is expected to drive leverage reduction towards 5.0x by fiscal 2020.

Hornbach's CFR is also constrained by (1) intense competition in the do-it-yourself (DIY) industry in Germany and the high level of digitalisation costs; (2) Hornbach's relatively small size compared with other European retailers; and (3) high level of capital spending associated with new store openings, which leads to negative free cash flow generation.

However the Ba3 CFR is supported by (1) strong position in its domestic market and good geographical diversification across Europe; (2) positive underlying growth, as reflected by its ability to outperform the market; and (3) a good liquidity profile, which is underpinned by the company's commitment to maintaining a conservative financial policy.

Hornbach's liquidity profile is good as it benefits from around EUR313 million cash on the balance sheet as of 31 May 2019 and an undrawn committed EUR350 million five-year revolving credit facility maturing in December 2023. The company's liquidity would be sufficient to refinance the EUR250 million worth of senior unsecured notes maturing February 2020.

STRUCTURAL CONSIDERATIONS

The Bond's Ba2 rating is one notch above the company's CFR because they benefit from senior guarantees from Hornbach's operating subsidiaries. These operating subsidiaries account for almost all of the company's tangible net assets and EBITDA. The EUR 295 million promissory notes issued in fiscal 2018 are not guaranteed by Hornbach's operating subsidiaries and are therefore subordinated to the Bond.

The Ba3-PD probability of default rating, in line with the CFR, reflects Moody's assumption of a 50% family recovery rate, typical for secured bond structures with a limited set of financial covenants. Some of the facilities contain financial covenants (interest coverage of at least 2.25x and equity ratio of at least 25%), which the company has been able to meet comfortably to date

RATIONALE FOR THE NEGATIVE OUTLOOK

The negative outlook reflects Moody's expectations that the company's leverage will increase to around 5.5x in fiscal 2019 and that that the company will need to sustainability grow its revenues and earnings in the next 12 to 18 months to reduce leverage towards 5.0x, a level which is commensurate with the current Ba3 CFR.

The outlook could be stabilized if in the next 12 to 18 months the company shows evidence that Moody's adjusted debt/EBITDA will trend towards 5.0x driven by an ongoing and sustainable increase in earnings and improvement in the company's FCF and interest cover, which are currently weak.

WHAT COULD CHANGE THE RATING UP/DOWN

The company is weakly positioned in the Ba3 rating category and as such, an upgrade is unlikely in the short term. Upward pressure on the ratings in the medium term could be exerted as a result of Hornbach's financial leverage decreasing below 4.5x on a sustained basis. A higher rating would also require the company to strengthen its Moody's adjusted EBIT margin above 4% on a sustained basis and the generation of positive FCF.

Conversely, downward pressure could be exerted on the ratings as a result of Hornbach's financial leverage failing to trend towards 5.0x supported by growing underlying revenues and profits. Downward pressure could also be exerted if interest cover decreases below 1.5x, if FCF remains negative and if the company's liquidity deteriorates.

PRINCIPAL METHODOLOGY

The principal methodology used in these ratings was Retail Industry published in May 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

CORPORATE PROFILE

Hornbach Baumarkt AG (Hornbach) is a mid-sized DIY retailer mainly operating in Germany, with 97 stores as of the end of fiscal 2018, and other European countries, including Austria (14), the Netherlands (14), the Czech Republic (10), Switzerland (7), Romania (6) Sweden (6), Slovakia (3) and Luxembourg (1). The company reported sales of €4.1 billion as of the end of fiscal 2018.

Hornbach's shares are listed on the Frankfurt Stock Exchange. Hornbach's parent company, Hornbach Holding AG & Co. KGaA, owns 76.4% of Hornbach's share capital, while independent investors own 23.6%. In turn, the Hornbach family owns 37.5% of Hornbach Holding's total share capital, and the remaining 62.5% are free float.

REGULATORY DISCLOSURES

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Francesco Bozzano
Asst Vice President - Analyst
Corporate Finance Group
Moody's France SAS
96 Boulevard Haussmann
Paris 75008
France
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Yasmina Serghini, CFA
MD-Corporate Finance
Corporate Finance Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
Moody's France SAS
96 Boulevard Haussmann
Paris 75008
France
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
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