Investing.com -- Moody’s Ratings has placed the A2 issuer and senior unsecured ratings of Seven & i Holdings Co., Ltd. (TYO:3382) (Seven & i) under review for a potential downgrade. Prior to this, the company’s outlook was stable.
The review comes in the wake of Seven & i’s recent announcement of a JPY 2 trillion share buyback, amid declining operating profits in its domestic and international convenience stores. This buyback is expected to limit the company’s leverage improvement over the next 12 to 18 months, according to Dean Enjo, a Vice President and Senior Analyst at Moody’s Ratings.
Enjo also stated that the proposed buyback, even though it is not debt-funded, indicates a higher financial risk tolerance than what is currently incorporated in its ratings. This suggests increased governance risk, as recent actions by the management seem to prioritize shareholder interests over creditor interests.
On March 6, Seven & i announced that it would fund the JPY 2 trillion share buybacks through cash proceeds from the divestments of its non-convenience store businesses in Japan and an Initial Public Offering (IPO) of a non-majority stake in 7-Eleven, Inc. (SEI, Baa2 stable). This move prevents immediate liquidity deterioration. However, it is unfavorable to creditors as it limits the debt reduction necessary to enhance credit metrics to a level more suitable for the ratings.
Furthermore, the IPO of SEI could significantly increase structural subordination risk for creditors at the holding company, depending on the final capital structure following the proposed transactions.
The operating profit of Seven & i has significantly decreased in the first three quarters of fiscal 2024, and a swift recovery is not anticipated within the next 12 to 18 months. This decline in profit is primarily due to inflating costs and inflationary pressures in its North American and Japanese convenience store operations. The recently announced divestments of its Superstore Operations and the deconsolidation of its Financial Services businesses are also expected to weaken EBITDA, further pressuring the company’s credit profile.
The A2 ratings of Seven & i reflect its leading position in the Japanese convenience store market, its growing overseas presence, and the high margin of its domestic convenience store chain. However, the ratings are also limited by its high leverage, resulting from declining EBITDA and high debt from several acquisitions. The company is also facing challenges in its major markets, such as Japan and North America, due to rising inflation and decreasing consumer demand.
Governance considerations were a key factor in the rating review. The company’s recent JPY 2 trillion share buyback announcement and the divestments in ownership of cash-generative businesses to fund this buyback indicate an increase in management’s financial risk tolerance that favors shareholders over creditors.
The review for downgrade will focus on several factors, including management’s plan to address its weakening credit profile, maintain liquidity, and contain its leverage as it executes the share buyback. The operating profile and capital structure of the group following the proposed asset disposals and IPO of its subsidiary SEI, and potential structural subordination risk for the creditors of Seven & i, will also be considered.
Moody’s Ratings stated that an upgrade of the rating is unlikely as the rating is currently under review for a downgrade. The rating could be downgraded if the company’s financial policies result in elevated risk of its leverage, as measured by debt-to-EBITDA, staying above the low-3x tolerance level of its rating. The rating could also be downgraded if there is a significant increase in structural subordination risk for creditors at the holding company due to proposed shareholder-friendly transactions.
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