Rating Action: Moody's downgrades Seven & i's ratings to A2 on its announcement of the Speedway acquisition; outlook negative
Global Credit Research - 04 Aug 2020
Tokyo, August 04, 2020 -- Moody's Japan K.K. has downgraded Seven & i Holdings Co., Ltd.'s senior unsecured debt rating to A2 from A1 and its senior unsecured shelf rating to (P)A2 from (P)A1.
The outlook on the ratings remains negative.
These rating actions follow Seven & i's announcement on 3 August 2020 that it has entered into a definitive agreement for its US subsidiary, 7-Eleven, Inc. (Baa1), to acquire the Speedway convenience store chain from Marathon Petroleum Corporation (Baa2) for USD21billion. The transaction is subject to customary approvals and is expected to close in Q1 2021.
The downgrade of the ratings reflects an expected spike in leverage following the Speedway acquisition, the biggest in Seven & i's corporate history, as well as the company's increasingly aggressive financial policy, as reflected by its newfound willingness to undertake a substantial, debt-financed acquisition.
The outlook on the company's ratings had been negative prior to the announcement of the Speedway acquisition, reflecting the struggle to maintain the profitability in its core domestic convenience store business as labor shortages have led to rising costs and discounts in franchise fees. The downgrade also reflects weak prospects for Seven & i's department stores, which are increasingly challenged by the decline of brick-and-mortar stores and the accelerating shift to online shopping. The economic slowdown from the coronavirus outbreak is likely to add to these strains.
Seven & i has yet to finalize its permanent financing plan for the acquisition, but if it funds the transaction entirely with debt as expected, the company's debt will increase by over 70%, while its EBITDA by only about 15%, based on its financial results for the fiscal year ended 28 February 2020 (fiscal 2019). Based on these estimates, Seven & i's debt/EBITDA will increase to around 4.2x-4.3x from 2.8x in fiscal 2019.
The Speedway acquisition, which is valued at about 30% of Seven & i's existing assets at a full multiple of almost 14 times EBITDA, points to a growing urgency to seek growth overseas amid weak growth prospects for its domestic businesses. Seven & i's implementation of growth strategies has been mixed, and the execution risk in integrating this large acquisition overseas, where business models are different and margins lower, will be significant.
Given the maturity of the convenience store market in Japan, Seven & i has been seeking to acquire convenience stores overseas. Its last major acquisition was that of Sunoco LP's US convenience stores for USD3.3 billion in 2018. In all, Seven & i currently has a large convenience store presence in North America, with 10,000 7-Eleven locations. Speedway will add about 4,000 more and increase Seven & i's overseas revenue to almost 60% from the current 40%.
The environmental, social and governance (ESG) considerations incorporated into today's action are primarily related to the governance risk indicated by the marked shift in Seven & i's financial strategy and risk appetite by undertaking this large, debt-financed acquisition.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
The negative outlook reflects the uncertainty around the final terms of the acquisition, including any divestments in the Speedway or 7-Eleven assets to comply with anti-trust requirements and permanent financing. It also takes into account the execution risk facing the company in restructuring its domestic operations to defend the profitability of its convenience stores and to turn around its department stores, exacerbated by the current economic downturn.
Given the negative outlook, an upgrade of the ratings is unlikely in the near term. However, Moody's could change the outlook to stable if (1) Seven & i finances the Speedway acquisition and executes on its integration such that it ensures leverage, as measured by debt/EBITDA, will be restored to under 3x within a couple of years of closing; and (2) the company demonstrates a sustained improvement in the operating margin of its superstore, department store and specialty store segments to 2%-3%.
Moody's could also downgrade the ratings if (1) the financing of the transaction results in a significant increase in Seven & i's leverage, such that its debt/EBITDA is sustained above 3x for a prolonged period, or (2) the department stores, the superstores and specialty stores do not improve profitability despite the restructuring efforts.
The principal methodology used in these ratings was Retail Industry (Japanese) published in May 2018 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1120382. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
Headquartered in Tokyo, Seven & i Holdings Co., Ltd. is a leading Japanese retail company with businesses including convenience stores, superstores, department stores and financial services.
For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
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Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.
Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.
At least one ESG consideration was material to the credit rating action(s) announced and described above.
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Mariko Semetko VP - Senior Credit Officer Corporate Finance Group Moody's Japan K.K. Atago Green Hills Mori Tower 20fl 2-5-1 Atago, Minato-ku Tokyo 105-6220 Japan JOURNALISTS: 81 3 5408 4110 Client Service: 81 3 5408 4100 Mihoko Manabe Associate Managing Director Corporate Finance Group JOURNALISTS: 81 3 5408 4110 Client Service: 81 3 5408 4100 Releasing Office: Moody's Japan K.K. Atago Green Hills Mori Tower 20fl 2-5-1 Atago, Minato-ku Tokyo 105-6220 Japan JOURNALISTS: 81 3 5408 4110 Client Service: 81 3 5408 4100
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