Friday 9 October 2015 10:43 am

Moody's to Tesco: Sales and profit performance must improve if you want to retain your credit rating

Moody's has said Tesco will need to "improve substantially" in the second half of this year if it is to meet its target operating profit of £940m. 

The embattled retailer this week released its first half results, recording a 55 per cent drop in group operating profit. Tesco also notched up a 1.1 per cent drop in UK sales, while UK group profit plummeted 69 per cent. 

The ratings agency said it expected the supermarket to "materially improve" profitability through slowing the decline of sales and the impact of chief executive Dave Lewis' cost-saving measures filtering through. 

But it warned that "ongoing structural changes in the UK grocery sector" would make it very difficult for Tesco to build profit margins to its historic levels of more than five per cent.  

The decision not to sell loyalty card business Dunhumby – which some have interpreted more as a sign that there was no appetite from prospective buyers – is "credit negative", Moody's said. 

"We understand the rationale of not selling an asset below its intrinsic value but we had expected material proceeds from the disposal that would have speeded up Tesco's balance sheet strengthening," it added. 

Moody's has not changed its Ba1 rating on the supermarket, but warned that in order to retain it, Tesco must "show it is at the start of a sustainable recovery".

To have its rating increased, Tesco will need to go even further, showing such an improvement in performance that it starts to grow UK like-for-like sales and improve profit margin to around three per cent. 

"An upgrade would also require the company continue strengthening its corporate governance and continue to demonstrate a commitment to a conservative financial policy," Moody's said. "Quantitatively, an adjusted debt/EBITDA ratio of 4.5x or below and a RCF/net debt ratio at least in the mid-teens would put positive pressure on the rating."