Fitch Affirms Future Retail at 'RD'

Fitch Ratings - Sydney/Mumbai -: Fitch Ratings has affirmed Indian retailer Future Retail Limited's (FRL) Long-Term Issuer Default Rating (IDR) at 'RD' (Restricted Default). Fitch has also affirmed FRL's USD500 million 5.6% senior secured notes due 2025 at 'C', with a Recovery Rating of 'RR5'.

The 'RD' rating reflects the uncured default in meeting repayment obligations on the bulk of FRL's onshore debt that was restructured under the Indian central bank's August 2020 One Time Restructuring (OTR) framework. We downgraded FRL to 'RD' in April 2021 after it completed the restructuring, as we viewed it a distressed debt exchange (DDE). However, the resultant debt structure and maturity profile remained unsustainable and did not meaningfully address FRL's financial stress, which is required for an upgrade after the completion of a DDE.

The 'RD' IDR on the international scale indicates an issuer that, in Fitch's opinion, has experienced an uncured payment default or a distressed debt exchange on a bond, loan or other material financial obligation, but that has not entered into bankruptcy filings, administration, receivership, liquidation or other formal winding-up procedure, and has not otherwise ceased business.

Key Rating Drivers

Uncured Default: FRL failed to repay INR88 billion in recast obligations under the OTR, comprising INR35 billion due on 31 December 2021, for which the grace period expired in January 2022, and INR53 billion due on 31 March 2022. This followed persistent operating losses since the financial year ending March 2020 (FY20) and ongoing litigation that has hampered FRL's ability to generate funds from alternative sources.

The obligations under default constituted 80% of FRL's restructured debt, underscoring its unsustainable maturity profile. FRL was also unable to pay the coupon on a INR2 billion domestic bond on 31 March 2022.

Risk of Deeper Restructuring: The risk of FRL undergoing a deeper restructuring or formal insolvency proceedings has risen in view of its default and the ongoing uncertainty in completing an announced business sale to an indirect subsidiary of Reliance Industries Ltd (RIL; BBB/Negative). A more conservative approach by onshore lenders, particularly after the closure of stores that accounted for 55%-65% of revenue in March due to non-payment of sub-lease rentals to RIL entities, can limit FRL's ability in managing its daily liquidity needs, including servicing debt outside the OTR.

Falling confidence by lenders may present additional hurdles in obtaining lender approval for the sale.

ESG - Management Strategy: FRL has an ESG Relevance Score of '5' for Management Strategy. We believe management continues to face multiple challenges. Persistently weak profitability since the onset of the Covid-19 pandemic and poor liquidity has impaired FRL's financial flexibility, leading to default on restructured debt obligations under OTR. Ongoing litigation and delays around the sale transaction pose significant impediments to management's strategy to improve financial flexibility. This has a negative impact on the credit profile and is highly relevant to the rating.

ESG - Governance: FRL has an ESG Relevance Score of '5' for Governance Structure. The Biyani family pursued growth investment at its operating companies rather than limiting leverage and preserving balance-sheet flexibility at the holding company. This is evident from significant reduction in FRL's main shareholder - Future Corporate Resources Pvt Ltd's (FCRPL) stake after lenders invoked share pledges. The reduced stake may present additional hurdles in securing shareholder approvals for the sale transaction. This has a negative impact on the credit profile and is highly relevant to the rating.

We believe the restrictions in the bond documentation limit the risk of cash leakage to shareholders. Nonetheless, distress at shareholders has caused reputational damage, constraining FRL's access to funding and liquidity.

Derivation Summary

FRL's rating reflects the uncured default on its onshore debt.

Key Assumptions

- Sales to drop by 51% in FY23 in view of store closures and poor liquidity

- EBITDAR margin to remain negative at -16.2% in FY23 (FY22 estimate: -16.6%)

- No dividends

Recovery Analysis Assumptions

- Fitch's recovery analysis assumes that FRL would be considered a going-concern in bankruptcy and would be reorganised rather than liquidated. We assume a 10% administrative claim.

- The going-concern value is based on a going concern EBITDA of INR4 billion and a 4x multiple.

- The going concern EBITDA assumption is about 60% lower than the INR10.4 billion EBITDA generated in FY19 - the last financial year prior to the impact of pandemic. Our lower EBITDA assumption underscore a deterioration in FRL's market position following a significant number of store closures. The going concern estimate is higher than actual performance since FY21, with FRL reporting persistent losses due to the impact of the pandemic and poor liquidity. This reflects our view that FRL's business model remains redeemable post restructuring and normalisation post pandemic.

- The 4.0x multiple is lower than the 5.5x median multiple for retail going-concern reorganisations to reflect FRL's mid-tier market position in India after considering store closures and intense multi-channel competition.

- We used FRL's post OTR debt structure, which includes accrued liabilities. Secured working capital and secured US-dollar notes account for the majority of FRL's debt. We assume that available but undrawn lines, if any, will be fully drawn.

- The recovery waterfall results in a recovery-rate estimate corresponding to a 'RR5' Recovery Rating for the USD500 million secured notes.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

- Positive rating action will require a resolution of default on FRL's debt. We believe this is unlikely in the near term considering the lack of visibility around an improvement in FRL's liquidity profile and potential debt restructuring.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

- The IDR will be downgraded to 'D' (Default) if FRL enters into bankruptcy proceedings, administration, receivership, liquidation or other formal winding-up procedure or if it ceases operation.

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. 

Liquidity and Debt Structure

Persistent Liquidity Crunch: Sustained operating losses have impaired FRL's liquidity and debt-servicing ability, leading to a default on its onshore debt obligations. FRL has managed to pay the coupons on the US-dollar notes, but only after the scheduled date. The risk of non-payment of coupon on the notes has increased after store closures and further risks could arise if onshore lenders impose additional restrictions.

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.

ESG Considerations

FRL has an ESG Relevance Score of '5' for Management Strategy, which reflects the limitations on management's ability to implement its strategy amid poor liquidity and ongoing litigation delaying the progress on the sale of the business. This has a negative impact on the credit profile and is highly relevant to the rating.

FRL has an ESG Relevance Score of '5' for Governance Structure, due to the shareholding concentration and presence of highly leveraged related parties. This has a negative impact on the credit profile and is highly relevant to the rating.

FRL has an ESG Relevance Score of '4' for Social Impact, reflecting the risk to its business from a shift by consumers towards online shopping. This has a negative impact on the credit profile and is relevant in the rating in conjunction with other factors.

FRL has an ESG Relevance Score of '4' for Financial Transparency, reflecting limited disclosure and delays. This has a negative impact on the credit profile and is relevant in the rating in conjunction with other factors.

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity.