(The following statement was released by the rating agency)
July 06 -
-- U.K.-based tour operator Thomas Cook Group PLC (Thomas Cook) continues to face significant operating challenges, with weak discretionary spending deepening the structural changes hitting the industry, and Thomas Cook in particular.
-- We believe Thomas Cook will face difficulties in stabilizing operating performance and cash flow generation in the next 12-18 months, as lower profitability margins are combined with an increased need of restructuring costs to improve competitiveness in some of its key markets.
-- We are therefore lowering our long-term corporate credit rating on Thomas Cook to 'B-' from 'B'.
-- The negative outlook reflects our view of ongoing pressures on Thomas Cook's operating performance and factors in a possible further downgrade if the group's liquidity position deteriorates further.
On July 6, 2012, Standard & Poor's Ratings Services lowered to 'B-' from 'B' its long-term corporate credit rating on U.K.-based tour operator Thomas Cook Group PLC (Thomas Cook). The outlook is negative.
At the same time, we lowered our issue rating on Thomas Cook's unsecured notes to 'B-' from 'B'. The recovery rating on this debt remains unchanged at '4', indicating our expectation of meaningful (30%-50%) recovery in the event of a payment default.
The rating action primarily reflects the deterioration in Thomas Cook's business risk profile, which we now assess at the low end of the 'weak' category under our criteria. It also reflects our expectation of continued weakening in the group's credit metrics over the near to medium term; the group's financial risk profile is now well within the 'highly leveraged' category.
We view positively the recent extension of the group's short-term maturities through to 2015 and its progress in asset disposals, which have eased short-term liquidity concerns. However, we believe that the lack of visibility on any inflection point on earnings and cash flow generation represents a key concern that could materially affect liquidity and, potentially, make the current capital structure unsustainable over the long term. In our view, this could jeopardize any refinancing attempt as the 2015 maturity wall approaches.
In our opinion, structural competitive changes in the industry--such as shorter times from booking to vacation and tightening competition following increased penetration of online travel agencies, as well as more people booking holidays directly on the Internet--have generated downward pressure on Thomas Cook's pricing and margins. The group's adjusted EBITDA margin in financial 2011 (ending Sept. 30, 2011) was 4.4% (4.8% in 2010), and we forecast further deterioration in financial 2012 (3.3% as of September 2012) and no material improvements beyond that. Lower profitability and declining cash flow generation capacity, in our opinion, are likely to constrain credit metrics and, over the medium to long term, could affect considerations on the sustainability of the capital structure.
In response to these structural changes and the difficult trading environment, Thomas Cook has cut capacity and increased its focus on online distribution and differentiated packages (that is, specialized and exclusive holiday products). Differentiated packages are difficult to replicate and therefore generate better margins.
Although we view such recent strategic developments favorably, we believe that they present significant execution risks because of the intense competitive environment and recent changes in customer behavior. In our view, Thomas Cook is lagging behind its main competitor TUI Travel PLC (part of TUI AG; B-/Stable/--) in coping with the industry changes, due to its lower share of differentiated products and online sales. Moreover, in our opinion, Thomas Cook will face significant hurdles to stabilize its operating performance and sources of liquidity, as the unpredictability of consumer behavior and the potential need for sizable booking discounts to fill capacity combine with ongoing restructuring costs to improve competitiveness in certain key markets. We therefore see increased business risk for Thomas Cook in containing the pressure on profits and cash flow that will likely result in such a rapidly evolving market.
For financial 2012, we project EBITDA (post operating exceptional items) at about GBP310 million (about a 25% decline from financial 2011). We also anticipate that top-line and profitability pressure will continue in 2013. In light of the difficult operating environment, and deteriorating profitability and cash flow generation capacity, we forecast weakening credit ratios over the short to medium term. In particular, in 2012, we project Standard & Poor's-adjusted debt to EBITDA of more than 6.5x, funds from operations to debt of about 12%-13%, and adjusted EBITDA interest coverage of about 2.0x. Under our current base-case credit scenario we do not anticipate a material improvement from these levels in 2013.
Despite a recent maturity extension and covenant reset, we assess Thomas Cook's liquidity as 'less than adequate' under our criteria.
In our opinion, there are significant uncertainties and limited visibility surrounding the timing and level of the inflection point in Thomas Cook's earnings and cash flow. We attribute this to the group's current operating performance and an environment that is unfavorable to the traditional tour operator business model. These risks exist despite the implementation of Thomas Cook's new business strategy to focus on differentiated products packages, and the ongoing restructuring of the business underway in countries such as the U.K. Furthermore, we believe these risks could lead to tightening covenant headroom and substantial volatility in the group's sources of liquidity.
Nevertheless, we calculate that liquidity sources should cover uses by about 1.2x over the 12 months to Sept. 30, 2012, and particularly at the end of the calendar year, when there is likely to be a seasonal trough. Our base-case scenario assumes contracting EBITDA in financial 2012 and some stabilization in the following year.
Our overall liquidity assessment takes into account the significant 2015 maturity and material refinancing risk, particularly if Thomas Cook is unable to stabilize its business and turn around its weak operating performance.
Factors supporting our liquidity assessment are:
-- Our projection of tightening covenant headroom, in a scenario where the group is not able to improve its profitability. According to our projections, headroom on the tightest covenant test (leverage ratio) could be less than 15% in the second half of 2012, with possible issues as early as June 2013.
-- Our view that Thomas Cook does not have the capacity to absorb high-impact, low-probability events.
-- Our view that the trading price of the group's debt instruments is an indicator of its poor standing in the credit markets.
That said, in our opinion, key factors supporting the group's liquidity are:
-- The lack of a debt amortization schedule over the next two years, following the recent maturity extension.
-- Our view of Thomas Cook's sound relationship with its banks, as highlighted by the recent agreements to reset covenants and provide an additional facility to cope with seasonal working capital peaks (November 2011), and by the recent maturity extension (May 2012).
The issue rating on the GBP300 million and EUR400 million senior unsecured note issues (together, the notes) issued by Thomas Cook is 'B-', in line with the corporate credit rating. The recovery rating on the notes is '4', indicating our expectation of average (30%-50%) recovery in the event of a payment default.
The main factors influencing the recovery rating are the unsecured nature of the notes; Thomas Cook's multijurisdictional exposure, which could delay or lower ultimate recoveries; the potential for additional liabilities arising from revenues received in advance; and various guarantees that Thomas Cook gives to travel regulators in the form of bonds.
In order to determine recoveries, we simulate a hypothetical default scenario. In our hypothetical scenario, we assume pressures on Thomas Cook's revenues, mainly fueled by the deterioration in the global economy leading to a contraction in the average customer spend. We also assume a drop in the group's profitability due to increased price competition and more and more customers choosing alternative ways of booking holidays, such as through online travel agencies or elsewhere on the Internet.
Following the recent maturity extension, our simulated default is triggered by a liquidity shortfall as a result of significant working capital swings in 2014 (from 2013 under our previous hypothetical default scenario, after the successful refinancing).
Under our default scenario, we use a proxy EBITDA (pre operating exceptional items) of about GBP360 million by the time of default in 2014 (slightly lower than the GBP400 million under our previous hypothetical scenario and reflecting deepening challenges in stabilizing the operating trend). We value Thomas Cook on a going-concern basis due to its leading market position among European travel companies and our assessment that in a default scenario, the business would retain more value as a going concern than in liquidation.
We use a market multiple methodology to determine Thomas Cook's stressed enterprise value. We calculate an enterprise value of about GBP1.45 billion at our simulated point of default (down from GBP1.6 billion in our previous scenario), equivalent to an EBITDA multiple of 4x. The group's valuation and outstanding debt fluctuate over the year, in line with the seasonality typical of the industry.
After deducting priority liabilities (such as administration costs, finance leases and a fully drawn GBP110 million new money facility, assumed to be reduced from GBP200 million on finalization of the disposal of the Indian business) and assuming a fully drawn revolving credit facility and other committed facilities, we project recovery prospects at the low end of the 30%-50% range for unsecured noteholders. Our recovery calculation also takes into account the potential for nondebt claims related to Thomas Cook's customer advances or bonding guarantees.
The negative outlook reflects our view of the ongoing pressure on Thomas Cook's operating performance. In particular, we believe that Thomas Cook's liquidity profile may deteriorate further due to the difficult macroeconomic environment affecting consumers and their discretionary spending. Furthermore, the group faces the challenge of successfully addressing the structural changes affecting the industry. We anticipate that this situation will continue throughout 2012 and possibly beyond.
We could lower the rating if it appears likely that the declines in profits and cash flow are not moderating and further hampering liquidity (particularly with regard to the key fourth calendar quarter). In addition, weakening operating performance could affect covenant compliance as soon as mid-2013.
In our view, in such a scenario, Thomas Cook's current capital structure could become unsustainable over the medium to long term. Therefore, our negative outlook also takes into account the increasing risk that the group could possibly undertake credit-dilutive debt restructuring measures. We will monitor this risk closely because we would view such debt restructuring as tantamount to a default under our criteria. However, we are not currently aware that Thomas Cook is taking any tangible steps in this direction. A material deterioration in coverage metrics--such as adjusted EBITDA interest coverage nearing 1.0x--could also put the rating under pressure.
We deem a revision of the outlook to stable to be remote in the short term. This is because such action would be dependent on us being confident that Thomas Cook could maintain at least adequate (15%) covenant headroom. It would also be dependent on Thomas Cook stabilizing revenues, EBITDA, and free cash flow, and addressing its short-term liquidity issues and financing needs.
Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated.
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
-- Criteria Guidelines For Recovery Ratings On Global Industrials Issuers' Speculative-Grade Debt, Aug. 10, 2009
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
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