Frankfurt am Main, December 04, 2018 -- Moody's Investors Service ("Moody's") has today downgraded the corporate family rating (CFR) of the British tourism group Thomas Cook Group plc (Thomas Cook) to B2 from B1 and its probability of default rating (PDR) to B2-PD from B1-PD. Moody's has also downgraded to B2 from B1 the ratings on Thomas Cook's senior unsecured notes. Concurrently, the outlook on Thomas Cook Group plc has been changed to negative from stable.
"Our rating action reflects the deterioration of credit metrics after unfavourable earnings development in the fiscal 2018 and the group's weakened liquidity. Furthermore, the negative outlook reflects Moody's concerns regarding the company's ability to recover its profitability and cash generation in the coming fiscal year as the macroeconomic tailwind becomes less supportive whereas the outcome of Brexit negotiations and their potential impact on customer behavior that may include a shift to late bookings exacerbates the uncertainty" says Vitali Morgovski, a Moody's Assistant Vice President-Analyst and lead analyst for Thomas Cook.
RATINGS RATIONALE
Thomas Cook's earnings in the fiscal 2018 dropped sharply as the company suffered from a prolonged period of unusually hot weather this summer that was evidenced across all of its source markets in Europe. While the first half-year of the fiscal 2018 developed strongly and Thomas Cook increased capacity anticipating further positive business development, the demand dropped sharply in the summer months as customers delayed their holiday decisions putting profit margins under pressure. Despite initial guidance of a broadly stable EBIT development in 2018, group's underlying EBIT declined by 23% to GBP250 million.
The company is currently in the process of executing its strategy, focusing on a differentiated holiday offering to transform its business model. The group's hotel portfolio is built around the pool of 186 higher margin own-brand hotels. Thomas Cook has signed partnerships with Expedia and Webjet on more commodity-type hotels, providing its customers greater choice at a lower cost. In partnership with LMEY a hotel fund has been established in order to accelerate the development of the own-brand hotels, targeting 10-15 new hotels by 2020. Direct costs have been reduced and the proportion of online sales grew to 48% of bookings.
However, transformational programme and start-up costs resulted in a significant increase of exceptional items (most of which Moody's does not adjust for) totaling GBP153 million, up GBP54 million from the previous year. High and growing amount of transformational expenses contrasts sharply with Moody's expectation of their gradual decline. In addition to exceptional items, hotel fund investment, final payment to Co-op along with adverse working capital development caused by delayed customer bookings resulted in close to GBP 200 million negative free cash flow (Moody's adjusted). Retained cash flow (RCF)/ net debt (Moody's adjusted) deteriorated markedly to 15.4% from 23.4% and the gross leverage ratio (Moody's adjusted) rose to 5.3x from 4.6x at the end of September 2017, while the cash balances were simultaneously materially coming down. Moreover, the interest cover fell below 1x, which is very weak for a B2 rating category according to Moody's Business and Consumer Service Methodology.
The increase in leverage at the end of the year does not fully reflect the extent of the deterioration of the company's balance sheet. Due to Thomas Cook's extremely high business seasonality, the obligations to hotels and other service providers for the previous summer season are settled during the first fiscal quarter of the following year. Therefore, Moody's expects Thomas Cook will not only consume its available cash at the end of September 2018, but will also rely heavily on its revolving credit facility (as in previous years), allowing for GBP650 million cash drawdowns. This will increase the leverage ratio during the first fiscal quarter 2019.
Moody's believes that Thomas Cook's overall liquidity is still adequate. However, it has a limited headroom currently and is materially weaker than it was last year, as its cash position shrunk to GBP1 billion at the end of fiscal 2018 versus GBP1.4 billion in 2017.
The rating agency acknowledged positively the company's focus on improving its reported operating profit, including a target for lower amount of separately disclosed items, as well as its free cash flow generation. Moody's notes the Board's decision to suspend the dividend payment, though this measure by itself will not have any meaningful impact on group's credit metrics - GBP9 million was distributed to shareholders during the fiscal 2018.
RATIONALE FOR THE NEGATIVE OUTLOOK
The negative outlook reflects Moody's view that the company's weak credit metrics will leave limited room for further underperformance while its business model will remain exposed to increasingly common external shocks that can create volatility on the company's performance but also to the Brexit-related uncertainty.
WHAT COULD CHANGE THE RATING UP/DOWN
The rating could be downgraded if the Moody's adjusted EBITA/ interest expense ratio remains below 1.25x, the free cash-flow remains negative or if the group's liquidity profile deteriorates further.
The rating could come under positive rating pressure if the company were to demonstrate the resilience of its business model to external shocks; Moody's adjusted EBITA/ interest expense ratio were to increase sustainably towards 2x; Moody's adjusted RCF/net debt ratio were to stay above 15% throughout the seasonal swings of the year and the company were to improve its liquidity profile.
PRINCIPAL METHODOLOGY
The principal methodology used in these ratings was Business and Consumer Service Industry published in October 2016. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
PROFILE
Thomas Cook Group plc, based in London, UK, is Europe's second-largest tourism business after the market leader TUI AG (Ba2 positive). The company retains leading positions in the important outbound markets of Germany, the UK and Northern European countries. The company provides its 11 million customers an access to a broad variety of hotels with 186 own-brand hotels building the core of this portfolio. Furthermore, the group's Airline business with 100 aircrafts servicing 20 million customers is Europe's third largest airline to sun & beach destinations. In the fiscal year to September 2018 the group generated revenues of GBP9.6 billion. The company is listed on the London Stock Exchange.
AFFECTED RATINGS
Downgrades:
..Issuer: Thomas Cook Group plc
.... Probability of Default Rating, Downgraded to B2-PD from B1-PD
.... Corporate Family Rating, Downgraded to B2 from B1
....Senior Unsecured Regular Bond/Debenture, Downgraded to B2 from B1
..Issuer: Thomas Cook Finance 2 plc
....Senior Unsecured Regular Bond/Debenture, Downgraded to B2 from B1
Outlook Actions:
..Issuer: Thomas Cook Finance 2 plc
....Outlook, Changed To Negative From No Outlook
..Issuer: Thomas Cook Group plc
....Outlook, Changed To Negative From Stable