Fitch warns of rating pressure from sterling slide
Source - SMW
The recent further slide in sterling, if maintained, will increase pressure on some UK corporate ratings, particularly in the retail and airlines sectors, Fitch Ratings warns.
It says currency hedging and other self-help measures will limit the near-term financial impact but ratings could be affected if companies are unable to rebalance capital structures or limit the impact on the cost of imported goods when hedges expire.
The pound is now down nearly 20% since the start of 2016 - a scenario that Fitch considered in a July report shortly after the Brexit vote.
Its analysis of 13 Fitch-rated companies that were potentially most exposed to currency depreciation indicated that retailer New Look could face the biggest impact on its leverage and credit profile, followed by Tesco and, to a lesser extent, British Airways.
This is largely driven by the rising cost of imported goods and, in some cases, a mismatch between the proportions of foreign-currency revenue and debt, which can increase debt-service costs as the pound weakens.
The analysis was done on an unhedged basis to determine corporate vulnerability over the medium and long term.
In common with other retailers, New Look and Tesco both use derivatives to hedge their foreign-currency exposures, but these do not always cover all their exposure and are generally for a maximum of 12 to 15 months.
Fitch's calculations indicate a 20% drop in sterling could increase New Look's unhedged leverage (FFO adjusted gross leverage) towards 7.9x (vs 6.8x at FY ended March 2016).
The company can still mitigate margin erosion, as seen when the pound fell 28% in 2009, by rationalising its cost structure, negotiating with suppliers and optimising supply-chain infrastructure and sourcing geographies.
Fitch says: "Not all hedging strategies are the same and some only provide protection within a certain range, meaning some retailers may have limited protection against further declines.
"This was demonstrated by Sports Direct's profit warning following the recent extreme sterling volatility, when it said its sterling/US dollar hedge had crystallised at a rate of 1.19, which would reduce forecast underlying EBITDA by £15m.
"Our analysis of a 20% sterling depreciation showed that Tesco's unhedged leverage would rise meaningfully. As the country's largest retailer, we believe it will be able to mitigate the impact once hedges expire by sourcing from cheaper locations.
"But this could increase tensions with suppliers, leading to more disruption such as the retailer's temporary decision to remove Unilever products from its website following a pricing dispute."