Fitch Ratings has assigned first-time Long-Term Foreign Currency and Local Currency Issuer Default Ratings (IDRs) of 'BB+' to Nueva Elektra del Milenio, S.A. de C.V. (NEM).
The Rating Outlook is Negative.
NEM's ratings are equalized to those of its parent company Grupo Elektra S.A.B. de C.V. (Grupo Elektra, BB+/Negative) and viewed on a consolidated basis. This reflects Fitch's view of a strong linkage (legal, operational and strategic) between NEM and Grupo Elektra due to the importance of NEM for its parent. NEM operates one of the two main businesses of the group and is the subsidiary that operates the Mexican retail business and is the parent company of the retail businesses in Latin America for Grupo Elektra. Fitch also views NEM's operations as integral to Grupo Elektra's core business, and some of its cash flows are used to pay Grupo Elektra's debt. While most of Elektra's debt, excluding the bank, is allocated at the holding company, the ratings incorporate that allocation of debt may be more balanced between the holding company and NEM in future.
Grupo Elektra's ratings reflect its long-term retail trajectory, market position as one of Mexico's main consumer retail chains, operational and financial linkage with Banco Azteca S.A. (BAZ; A+(mex)/Negative) and sizable liquidity position and financial flexibility. The ratings also consider Fitch's view of the company's related parties' aggressive treatment toward different stakeholders, which weakens governance.
Grupo Elektra's Negative Outlook reflects the impact of the coronavirus pandemic and related disruptions on the non-food retail sector and the expected downturn in discretionary spending that could extend into 2021. Fitch estimates Grupo Elektra's consolidated gross adjusted leverage to increase close to 4.0x by YE 2020 from 2.5x in 2019, mainly as a result of lower revenues in the retail business and lower profitability margins driven by higher non-performing loans (NPLs) from the financial business. Consolidated adjusted leverage is expected to recover to levels below 2.5x during 2022, assuming a gradual and sustained revenue and profitability recovery. A more prolonged or severe downturn could lead to negative rating actions.
KEY RATING DRIVERS
Challenging Retail Environment: Non-food retail sales have been negatively affected in most countries where Grupo Elektra operates as the coronavirus outbreak included temporary closures of non-essential stores. However, most Grupo Elektra's stores in Mexico did not stopped operations as all of them contain BAZ branches within the stores and financial services are considered essential activities.
Fitch believes traffic to Grupo Elektra's stores will continue to be negatively affected by the pandemic while containment measures by local authorities last. Fitch also believes social distancing measures will affect consumer behavior even after the restrictions are lifted, which together with the expected pressure on consumers' household incomes may weaken consumer demand on discretionary items and impact the recovery speed of non-food retailers' revenues during second-half 2020.
Expected Weakened Leverage: Fitch's primary focus on Grupo Elektra's credit metrics considers only the retail business, excluding financial businesses. Following this approach, Grupo Elektra's retail-only gross adjusted debt/EBITDAR was 3.7x in December 2019, an increase from previous years due to the company's higher sales in low-profitable categories as well as intense competition. Fitch estimates Grupo Elektra's retail-only gross adjusted debt/EBITDAR to go up to around 4.9x by YE 2020 based on lower revenues and higher debt levels. In addition, Fitch estimates Grupo Elektra's retail-only adjusted leverage ratios will recover to levels below 3.5x in 2022 as long as the company manages to recover revenues and profitability presented in the past.
Using the captive finance adjustment, as per Fitch's criteria, consolidated gross adjusted debt/EBITDAR was 2.5x as of Dec. 31, 2019. Fitch expects this ratio to increase close to 4.0x by YE 2020 due to lower revenues and lower profitability margins driven mainly by BAZ's higher NPLs provisions. This adjusted leverage ratio is expected to recover and trend to below 2.5x by 2022. Where financial services (FS) activities are consolidated by a rated entity, Fitch criteria assumes a capital structure for FS operations, which is strong enough to indicate that FS activities are unlikely to be a cash drain on retail operations over the rating horizon. Then the FS entity's debt proxy, or its actual debt (if lower), can be deconsolidated and the remainder debt used for credit metric calculations.
Strong Market Position: Grupo Elektra's market position is supported by the diversification of its operations and linkage with BAZ, a Mexican bank with the most granularity in the country. Grupo Elektra has a 70-year track record in the commercialization of consumer durable goods, with operations in five Latin American countries including Mexico. The company also has a presence in the U.S. through its subsidiary Purpose Financial Inc. (formerly Advance America), a payday lending and other short-term financial services provider.
Grupo Elektra's omnichannel strategy includes not only retail but also a financial business component. Since 2016 the company has invested in servers and IT platforms to help support innovations that will allow it to stay updated with consumer trends. Elektra generates about 80% of the group's consolidated revenues in Mexico, including retail and financial businesses. However, Fitch believes operations in other countries across Latin America and the U.S. somewhat mitigate revenue concentration.
BAZ Complements Elektra's Business Model: The linkage between Grupo Elektra's retail and financial divisions is strong as both depend on one another to complete service offerings to customers. The retail division complements its product sales by offering BAZ credit services, while BAZ maintains a strong base of customers derived from Elektra and Salinas y Rocha's shoppers. Notwithstanding the above, according to Fitch's Parent and Subsidiary Rating Linkage criteria, legal ties between Elektra and BAZ are weak due to the absence of guarantees and cross default clauses between them. Fitch's approach for Grupo Elektra's ratings incorporates future capital injections BAZ might require from Grupo Elektra. Current assumptions consider no additional capital injections in the medium term other than the one recently executed.
BAZ's National Long-Term Rating of 'A+(mex)' with a Negative Outlook reflects Fitch's expectations that the bank's operations will be negatively affected given its business model focused on low-income individuals, which Fitch considers to be more sensitive to economic cycles. Fitch expects BAZ's profitability to be impacted due to deterioration in asset quality and the extraordinary impairment provision related to an important client that went into bankruptcy. BAZ has a robust position in its main market, consumer loans to the medium-low income segment of the population. Its ratings also include the bank's solid funding structure through an ample, stable and diversified base of customer deposits, its sound liquidity position and capacity to adjust to adverse operating environments.
Continued Positive FCF: Grupo Elektra's consolidated FCF has remained neutral to positive over the last seven years, despite increasing capex and economic cycles. In 2019, the company's FCF was MXN26.1 billion, and Fitch expects it to continue to be positive in 2020 and beyond.
Fitch estimates Grupo Elektra's capex for 2020 to be lower compared with the two previous years given the current operating environment in Mexico. Capex will be mainly focused on store remodeling and IT developments for the retail and banking operations to support its commercial strategy.
Currency Exposure Partially Mitigated: While debt is mainly composed of local currency issuances, some of Grupo Elektra's inventory is exposed to currency variations as a portion of it is linked to the U.S. dollar. This could potentially pressure profit margins for some products if this effect is not reflected in price increases, which might in turn affect sales volumes if the effect is passed through prices. However, this exposure is partially mitigated by Purpose Financial's cash flows and money transfer fees collected in U.S. dollars by Grupo Elektra. Grupo Elektra has partially covered its U.S. dollar cash flow exposure for 2020 by entering in forward contracts.
DERIVATION SUMMARY
NEM's ratings are supported by the credit profile of Grupo Elektra, which is well positioned as one of the most important stores focused on the mid to low economic segment of the population in Mexico and some countries in Latin America. Grupo Elektra's scale is larger than Grupo Unicomer (BB-/Stable) and Grupo Famsa (D) and holds one of the largest credit portfolios held by a retailer in the region. The company is less geographically diversified than Grupo Unicomer; however, Mexico and the U.S. are the countries that generate the most cash and have lower country risk than most of Unicomer's countries of operations.
Grupo Elektra's financial profile is strong when compared to peers. The company has a solid financial profile compared to other retailers and sound financial flexibility due to its high levels of cash and marketable securities. Grupo Elektra's profitability for its retail business is above the average of Fitch's rated retailers globally, and its operating margins and liquidity are higher than those of Grupo Unicomer and Grupo Famsa.
KEY ASSUMPTIONS
Fitch's key assumptions within our updated rating case for Grupo Elektra include:
Fitch base case projections for 2020 considers a decline in retail revenues for a three-month period and then a gradual recovery by year end;
Consolidated revenues grow 6% annually for 2021-2023.
Annual growth of 4.0% in banking deposits;
The consolidated gross credit portfolio declines in 2020 and then grows at 4% per year on average during 2021-2023;
NPL provisions of MXN12 billion for 2020 and thereafter average of MXN9.2 billion per year;
Capex of MXN8.4 billion annually, on average;
Dividend payments growing at 5% per year;
The company refinances its debt maturities and raises additional debt for MXN2.5 billion during 2020.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
NEM's Negative Outlook could be revised to Stable if Grupo Elektra's Negative Outlook is revised to Stable. Grupo Elektra's ratings could be revised to Stable from a combination of one or more of the following: if Elektra's financial performance is better than Fitch's expectations, the adjusted leverage for the retail business results close to or below 3.7x in 2021 and/or the consolidated adjusted leverage is at or below 2.7x in 2021.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
NEM's ratings would be pressured by negative rating actions on Grupo Elektra. Grupo Elektra' ratings could face pressure from a combination of one or more of the following: sustained adjusted debt/EBITDAR for the retail division above 3.7x, sustained adjusted net debt/EBITDAR for the retail division above 2.7x (including readily available cash equivalents, as per Fitch's calculations), sustained consolidated adjusted debt/EBITDAR (as per Fitch's criteria) above 2.7x, sustained deterioration in BAZ's creditworthiness, or a deterioration in governance perception.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
LIQUIDITY AND DEBT STRUCTURE
Sound Liquidity for Grupo Elektra: As of June 30, 2020, cash for the retail division was MXN6.1 billion and short-term debt was MXN11.2 billion. Short-term debt is mainly composed of local issuances maturities for a total of MXN9.8 billion, which are going to be refinanced. In addition, the retail division presented MXN14.6 billion of marketable financial instruments portfolio as of June 30, 2020. Fitch considers the cash and marketable securities at the retail business as readily available cash as there are no constrains in its disposition. On March 2020, Grupo Elektra's retail division injected MXN7.2 billion of cash to BAZ due to a capital requirement from the bank.
SUMMARY OF FINANCIAL ADJUSTMENTS
Financial statements were adjusted to revert the effect of IFRS 16.
DATE OF RELEVANT COMMITTEE
04 September 2020
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
RATING ACTIONS
ENTITY/DEBT RATING
Nueva Elektra del Milenio, S.A. de C.V. LT IDR BB+ New Rating
LC LT IDR BB+ New Rating
VIEW ADDITIONAL RATING DETAILS
Additional information is available on www.fitchratings.com
GRUPO ELEKTRA, S.A.B. DE C.V. 
