OREANDA-NEWS. Fitch Ratings has affirmed Whitbread Plc's (Whitbread) Long-Term Issuer Default Rating (IDR) at 'BBB' with a Stable Outlook and Short-Term IDR at 'F2.'

Fitch has also affirmed the senior unsecured rating for Whitbread Group Plc at 'BBB'. Whitbread Group Plc is the main entity that issues debt within the group. All bonds have guarantees from Whitbread Plc and main subsidiaries Premier Inn and Costa Limited.

The ratings continue to reflect Whitbread's strong leading market position in the UK mid-scale hotel segment, where it is targeting 85,000 rooms by 2020 through its Premier Inn (PI) brand, and a growing Costa Coffee (Costa) shop network both in the UK and internationally. We expect the company's significant expansion programme to generate a further improvement in revenues and EBIT profits/margins in 2016 at PI as occupancy rates remain strong on the enlarged rooms portfolio and room prices continue to rise, albeit a more moderate rate than previously .

However, required capex, combined with relatively high taxes, continued significant pension contributions and dividend payments will mean that free cash flow (FCF) generation will be negative until the financial year to February 2019. It will also mean leverage will increase although it should remain within our guideline for a 'BBB' rating, albeit with now more limited flexibility. Whitbread has also reiterated its commitment to maintain a financial discipline compatible with its current rating with a maximum lease-and-pension-adjusted net debt/EBITDARP of 3.5x. The company could also defer or cancel some capex in the next three years to maintain leverage ratios within the given guidelines.

The constraints on the company's ratings are the cyclicality, albeit moderate, of the mid-scale hotel business and a lack of geographical diversification, although this is likely to improve over the medium term following expansion in Germany and in emerging markets.

KEY RATING DRIVERS
Leading UK Hospitality Business
The ratings reflect Whitbread's leading position in the less cyclical mid-scale segment of the UK hospitality sector, with its PI brand. It benefits from a well-invested estate and business customers choosing less expensive hotels. About 75% of the group's operating profit is generated by hotels and restaurants, and 25% by Costa Coffee. Although the mid-scale hotel segment remains competitive in the UK, PI remains well positioned to gain market share from independent hotel chains.

Slowing Positive Trading Performance
Whitbread continues to perform well like-for-like (lfl) sales grew 3.2% in FY16), with PI in particular benefiting from a recovering hotel market, particularly in the UK regions and from continued fragmentation in the UK mid-scale hotel market. Fitch expects PI's operating performance to remain positive in FY16, although we expect lfl growth to moderate in 2016, as both room rate rises slow and occupancy stabilises. Costa Coffee should also see increased revenue and operating profits due to reasonably good opportunities in the UK regions although lfl store sales and profit growth is beginning to slow as the market shows some early signs of saturation in some metropolitan areas.

Freehold Expansion to Reduce FCF
Whitbread is pursuing strong organic revenue growth at its hotels division and at Costa Coffee. Despite our projection of sustained revenue growth and improved EBITDA in 2016 (to end February 2017), FCF should be negative due to higher capex and dividends. We expect FCF to remain negative until at least 2019, despite management's predicted EBITDA growth as a result of its well-executed-to-date expansion strategy. However, Whitbread remains committed to its investment grade rating and Fitch therefore takes into account management's ability to defer capex to ensure its financial metrics remain within the appropriate parameters.

Slight Increase in Leverage
Fitch expects some moderate pressure on Whitbread's credit metrics with funds from operations (FFO) adjusted net leverage of 3.3x-3.7x (equivalent to lease-and-pension-adjusted net debt/EBITDAR of around 3.0x) for FY16 and FY17 due to high expansionary capex and operating leases increase. However, we estimate that Whitbread has the flexibility to reduce its freehold investments and cut dividends should leverage increase beyond levels compatible with the ratings. Whitbread has reaffirmed its commitment to its investment-grade rating status with lease- and pension-adjusted net debt/EBITDAR of below 3.5x.

Pension Deficit Recovery Plan Continues
The ratings capture Whitbread's fairly high annual cash pension contributions that are needed to shrink the pension deficit as agreed with the pension trustee. The deficit recovery plan implies a cash contribution of around GBP75m per annum on average stretching out to 2022. At FYE15, the pension deficit at GBP288m was lower than at FYE14 (GBP554m), due to a higher liability discount rate and aforementioned cash pension contributions. According to its methodology, Fitch includes the pension deficit in the calculation of adjusted leverage ratios.

Sustainable Liquidity
While we have affirmed the short term IDR at 'F2', continued negative free cash flow (FCF) in the next three years could reduce the current flexibility in Whitbread's liquidity profile. However, we acknowledge Whitbread's largely scalable capex plan, which can be partially deferred, in case of need, to boost FCF. This factor, along with further strengthening of other internal liquidity metrics and continuing external liquidity via committed available bank lines, supports our view of adequate sustainable liquidity that is consistent with a 'F2' Short-Term IDR.

KEY ASSUMPTIONS
Fitch's expectations are based on the agency's internally produced, conservative rating case forecasts. They do not represent the forecasts of rated issuers individually or in aggregate. Fitch's key assumptions within the rating case for Whitbread include:

- Revenue growth in the next three years driven mainly by hotel expansion and fairly moderate lfl sales growth, with stable occupancy and moderate average room rate (ARR) rises.
- ARR increasing just below inflation in 2016, reflecting some ability to increase prices to UK middle market consumers.
- Occupancy to remain fairly stable.
- Rents based on management's expectations of around GBP236m in FY16.
- Capex of around GBP700m in FY16
- Cash pension contributions GBP88m in FY16, GBP90m in FY17 and GBP90m in FY18
- Net divestments of between GBP50m and GBP70m in FY16

RATING SENSITIVITIES
Positive: Future developments that could lead to positive rating action include:
- Material geographic and product diversification and/or scale of business, along with continuing improvement in trading leading to an EBIT margin sustainably above 20% (FY15: 17.9%)
- Lease-adjusted EBITDAR/interest plus rents ratio above 4.0x (FY15: 3.5x) or FFO fixed charge cover above 3.5x (FY15: 3.1x).
- Reducing leverage, with Fitch's lease-and-pension-adjusted net debt/EBITDARP below 2.5x and FFO adjusted net leverage below 3.0x.
- Sustained positive FCF.

Negative: Future developments that could lead to negative rating action include:
- Deterioration in core businesses or rapid expansion leading to EBIT margin sustainably below 15%, combined with a sustained contraction in FCF generation.
- Lease-adjusted EBITDAR/interest plus rents ratio to below 3.0x or FFO fixed charge cover below 2.5x on a sustained basis.
- Significantly rising leverage, with Fitch's lease-and-pension-adjusted adjusted net debt/ EBITDARP sustained above 3.5x and FFO adjusted net leverage trending towards 4.0x, on a sustained basis.