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TescoGate: Credit rating downgraded in fear of shareholder litigation

Published:  24 October, 2014

Moody's Credit Agency further downgraded Tesco short and long-term credit in response to company's announcement yesterday that it had overstated profits by £263m. Tesco's ratings will remain on review for further downgrades due to concerns over the potential financial impact for shareholder litigation.

"We have downgraded Tesco's ratings because of the materially reduced trading profit for the first half of fiscal 2015 that is affected by the rapid structural changes in the UK retail grocery market as well as the ongoing uncertainties related to the investigation by the Financial Conduct Authority (FCA) into Tesco's accounting irregularities," said Sven Reinke, Moody's vice president and senior analyst for Tesco.

Moody's has decided to keep Tesco's credit rating on review for further downgrades.

"Given the ongoing legal investigation by the FCA, Moody's remains concerned about the risk of shareholder litigation and its potential financial impact as it has been confirmed that amounts have been pulled forward or deferred, contrary to the company's accounting policies," according to the Moody's report.

Regardless of the outcome of the investigation by FCA, the credit agency still sees massive operational challenges ahead for the supermarket giant. Tesco's new chief executive officer, Dave Lewis, has not provided a clear strategy on how to address the issues the company faces moving forward.  

Reinke said: "Even if the FCA concludes its investigation without material negative implications, Tesco faces huge operational challenges which continue to put its investment-grade rating at risk."

Adding to the uncertainty of the company's ability to finance its debts is Tesco has yet to announce a full year profit guidance for fiscal year 2015. It is also because of this uncertainty that Moody's is keeping the ratings on review for further downgrades.

"The ratings remain on review for downgrade because Tesco has not yet announced the outcome of its strategic review of the UK business and how it plans to tackle the longer-term challenges it faces due to the structural changes in the UK grocery retail industry. Tesco has not yet given a full year profit guidance for fiscal year 2015 either," said Moody's.

It is critical for Tesco's new leadership team to clearly define a strategy in how the company plans to stablize and adapt to the changing landscape of the retail market, said the global credit rating agency.

"The ongoing review will focus on the company's strategy to stabilize the trends in its operations, and improve its overall financial profile as it adapts to fundamental shifts within its home market. The outcome of the company's strategic review of its businesses, as well as the financial policies and business practices that its new management team will employ, will be critical elements of that assessment," said Reinke.

Moody's has downgraded its long-term credit credit from Baa2 to Baa3. Concurrently, Tesco's short-term rating also was downgraded from Prime-2 to Prime-3. Both levels are still lowest acceptable rating within Moody's rating range for short long term debt. According to Moody's credit scale, "Obligations rated Baa are subject to moderate credit risk. They are considered medium-grade and as such may posses certain speculative characteristics". 

The numerical modifiers 1, 2, and 3 is added to each generic rating classification from Aa through Caa. The 'modifier 3 indicates a ranking in the lower end of that generic rating category," according to Moody's website.