Victoria group (B-): Bond Placement Analysis

Last Wednesday, Russian food retailer Victoria group opened the application book for participation in two bond issues. Each issue is for RUB2 bn and is due in three years, with the first having a put option six months after the issue date, and the second having a put option after 1.44 years. The book closes on February 12, with technical placement likely to take place on February 16. Overall, the group has registered five issues totaling RUB10 bn.

Company overview

Victoria Group is Russia\'s ninth largest food retail chain, with stores located mainly in Moscow, St. Petersburg and Kaliningrad, in the latter of which Victoria has historically been market leader. As of YE2009 Victoria’s retail chain comprised of 206 stores operating in the supermarket, convenience store, economy convenience store and cash & carry formats. Victoria owns 36% of its selling space, although it does plan to reduce this to 20% in the future. 98% of the group’s shares are owned by its senior management and founders, Nikolai Vlasenko, Vladmir Katsman, and Aleksandr Zaribko.

Credit Profile

Given Victoria’s poor levels of transparency, there have been few opportunities to gain an accurate picture of its credit profile since the placement of the Victoria-Finance 2 issue in 2007. However, some positive developments have taken place:
• High Margins Maintained. Victoria’s 1H09 gross margin of 33.7% is far better than other Russian retailers. Even more important is that between January and July 2009 the company’s gross margin ratio actually gained 1.7pp, primarily driven by Victoria’s attractive business model that maintains high diversification of trading formats. 1H09 EBITDA margin stood at 7.5%, and although this was comparable to the company’s peers, it still represented a decrease, and was caused primarily by expanding operating expenses. Victoria intends address potentially eroding margins by increasing sales of own-label goods, which currently account for 7.2% of consolidated sales.
• 1H09 Operating Cash Flow (Before Working Capital Changes) of RUB1.6 bn – 13% increase y-o-y. We also note that the company has not applied the traditional crisis measure of reducing its working capital. We believe this may be due to a weaker negotiating position with suppliers compared to competitors.
• Conservative Debt Financing Policy. Victoria’s total outstanding debt has been reduced 12% to RUB4.4 bn since YE2008. Meanwhile, the debt/EBITDA ratio declined from its 2007 of peak of 4.4X to 1.9 X in 2008 and has since remained unchanged. The company’s unaudited 1H09 results reported that more than 93% of its total debt portfolio had a short-term structure; however, during 2H09, after the 1H09 reporting date, Victoria successfully reached an agreement with banks to refinance the majority of its loans. Therefore, apart from the forthcoming repayment of its second bond issue (RUB1.5 bn) on February 16, Victoria does not have any significant short-term redemptions. The company has made clear in its presentation for its two new issues that its opened credit lines combined with its balance sheet cash position is sufficient to meet all bondholders’ claims. Going forward Victoria aims for the gradual substitution of banking financing with wholesale funding.

There have also been rumors recently concerning a possible IPO which would involve selling 30% of the company’s shares. However, the company may eschew public listing in favor of attracting new financing from portfolio investors. We have a generally positive view on the company\'s plans, but recommend that investors refrain from becoming over excited about this news until further details emerge. Before then, given the placement of the new bonds, Victoria’s leverage, according to our estimates, will not be lower than a debt/EBITDA ratio of 3X.
Besides poor financial transparency, the main weaknesses of the company’s credit profile include a high level of competition in its priority development region, Moscow, as well as an insufficient level of downstream assets, such as the absence of a logistics arm from the group. Furthermore, Fitch, in a recent rating assignation press release, highlighted problems with corporate governance: specifically, loans to related parties, which totaled USD651 mn in 1H09, and the absence of restrictions on the payment of dividends, which allowed the company to pay a 1H09 dividend equaling 80% of the company’s net profit for the period, RUB244 mn – in our view, a less than prudent decision given the unfavorable operating environment at the time.

Conclusion

Victoria should be viewed as a third tier Russian retail sector bond issuer. In this sense, the results of Victoria’s forthcoming placements are also important as an indicator of demand for this type of risk. In our view, the marketing ranges for the bonds (coupon 12.24-13.25% for the first issue, 12.75-13.75% for the second) will look fair in terms of “risk/yield” only if it hits the Central Bank of Russia’s REPO list. Otherwise, we would recommend that investors look instead to the bonds of Dixie (yield about 17%).