OREANDA-NEWS. S&P Global Ratings today said it has revised to negative from stable the outlook on its long-term corporate credit rating on Japan-based retailer AEON Co. Ltd. We also affirmed our 'BBB+' long-term corporate credit and senior unsecured debt ratings on AEON.

The outlook revision reflects our view that a slow recovery in the profits of its mainstay general merchandising store (GMS) business and an increase in debt stemming from active investments keep the ratio of AEON's debt to EBITDA, one of the key financial indicators in our analysis, at higher levels than we previously expected. Also, although AEON's consolidated earnings performance is recovering gradually, we believe the likelihood, in our view, that AEON will continue heavy investments makes key financial indicators for the company including debt to EBITDA unlikely to substantially improve in the next one to two years. Nevertheless, we believe AEON's consolidated performance will remain on track to recovery. Therefore, we affirmed our long-term ratings on AEON.

AEON has progressed revitalization of its existing stores and a reshuffle of the merchandise lineup of its mainstay GMS business. However, the business' profits have been slow to recover, because its various restructuring measures need some time to take hold and because costs related to restructuring have increased. The profitability of the GMS business falls short of our previous assumptions and is likely to take time to fully recover amid softening consumption and continued, intensifying competition with other business formats. As a result, we have lowered our outlook somewhat for profits in AEON's GMS business. However, progress in restructuring group businesses is enhancing the company's supermarket and discount store business as well as its drugstore and pharmacy business. It has also helped ensure continued strong earnings performance in AEON's nonretail segments, such as its shopping center development and service businesses. As a result, AEON continues to gradually improve its consolidated earnings performance and diversify the group's sources of operating profit and business. Therefore, we believe AEON will maintain its strong market position and business franchise in the retail market. Accordingly, we continue to assess AEON's business risk profile as strong.

Investments to revitalize existing retail stores and develop new shopping malls at home and overseas expanded AEON's capital investments--11% year on year in fiscal 2015 (ended Feb. 29, 2016) to a high level exceeding ?500 billion--and its debt and operating leases. As a result, the ratio of its debt to EBITDA (excluding its financial services business) worsened to 4.1x as of the end of February 2016, exceeding our previous downgrade trigger of 3.5x (the ratio was about 3.6x as of the end of February 2015). While we expect AEON's consolidated earnings performance to continue to improve gradually, the likelihood, in our view, that AEON will maintain heavy investments to preserve its competitiveness leads us to believe its key financial indicators are unlikely to improve substantially in the next one to two years.

At the same time, because we take a hybrid approach of combining the retail business and shopping center development business, which produces stable cash flow from rental income, to assess AEON's financial risk profile, we set the indicative thresholds of cash flow leverage ratios for AEON less stringently than those for pure retailers. Amid a slow recovery in retail businesses, because the share of its shopping center development business' EBITDA to the company's overall EBITDA is increasing, we revised the indicative thresholds of the ratios to slightly closer to those of the development business. We take into account:Aeon's relatively strong EBITDA interest coverage ratio, which we assign extra weight in our analysis of its development business; The company's ongoing and entrenched banking relationships; andIts capability to balance between financial soundness and growth with an emphasis on financial discipline. Accordingly, we continue to assess AEON's financial risk profile as intermediate. However, given a slow recovery in major financial measures for the company, we see our room to maintain the assessment as narrowing.

Under our base-case scenario, we assume consolidated operating revenue will grow 2%-3% annually, operating profit in the GMS business will rise slightly thanks to revitalization of existing stores but at a slow pace of recovery, consolidated gross margin and operating profit will recover somewhat, and annual capital investments will remain high at about ?500 billion.

Under these assumptions, in the next one to two years we expect AEON's EBITDA margin to be about 7% and its debt to EBITDA to improve somewhat to just below 4x.

We assess AEON's liquidity as adequate and expect its liquidity sources to exceed 1.2x its uses in the next 12 months. Support for the company's liquidity also comes from its good relationships with several financial institutions, including Mizuho Financial Group Inc.

The negative outlook reflects our view that although AEON's consolidated earnings performance has improved gradually, a likelihood that AEON will continue heavy investments makes its financial standing likely to recover only slowly. Downward pressure on our ratings on AEON may grow if its consolidated operating profit falls year on year in fiscal 2016. This may occur if its retail business' operating profit shrinks despite the company's restructuring of its GMS business or if business restructuring within the group stalls. We may consider downgrading AEON if it relaxes its fiscal discipline, thereby increasing investments and reliance on debt, and we see a reduced likelihood its key financial indicators will improve. This would be the case if, in our view, its debt to EBITDA exceeds 4x as at the end of fiscal 2016.

We may consider revising the outlook to stable if profits in AEON's retail business recover in full and the company improves its financial standing to levels exceeding our assumptions through appropriate management of investment and debt levels. This will be the case if its debt to EBITDA falls below 4x and continues to ease on a sustained basis.