OREANDA-NEWS.  Fitch Ratings has affirmed the ratings of Australian-based retailer Wesfarmers Limited's (Wesfarmers) Long-Term Issuer Default Rating (IDR) and senior unsecured rating at 'BBB+'. The Outlook is Stable.

KEY RATING DRIVERS
Defensive Cash Flows: Wesfarmers' Long-Term IDR is supported by the material contribution from the defensive, mature and stable supermarkets sector. Supermarkets sell products that are essential for everyday life and exhibit low revenue and margin volatility. By diversifying into alcohol, fuel, and financial services, the Coles grocery and convenience store division has succeeded in trapping a greater share of its customer's spending.

Leading market share: Wesfarmers benefits from a strong market position and low competition in segments that contribute more than 80% of its consolidated EBIT. Coles and its main competitor, Woolworths Limited (Woolworths), account for a majority of supermarket sales and alcohol retail sales in Australia, as well as a large proportion of retail petrol sales. This market structure gives Coles and Woolworths significant market power and the ability to drive down input costs, passing on any cost increases to customers.

Diversified earnings stream: Wesfarmers's earnings are diversified by industry and geography, with its retail business spanning all eight states and territories in Australia. Wesfarmers' big-box discount retail businesses provide it with some counter-cyclicality, and the divestiture of the insurance businesses in FY14 has reduced tail risk. While most of the retail businesses have seen strong earnings growth in the past 18 months, this has been partly offset by a decline in earnings from the Resources, CEF (Chemical, Energy and Fertilisers), and Industrial & Safety sectors.

Financial Flexibility: Strong pre-dividend free cash flow and a material cache of unencumbered assets provides Wesfarmers with ample financial flexibility. Annual pre-dividend free cash amounts in excess of AUD1bn and cash and borrowing headroom of AUD4.2bn at 30 June 2014 took total liquidity to around AUD5.2bn, although this decreased somewhat following cancellation of an undrawn AUD1.25bn facility in August 2014.

Off-Balance Sheet Debt Increases: The leverage resulting from property sales and leasebacks will continue to be captured in Fitch's leverage metrics through the rental multiple. In FY14 Wesfarmers executed the sale and leaseback of a portfolio of 12 Bunnings stores realising \$282m, and 15 Bunnings warehouse properties via a securitised lease transaction realising \$309m. The company also continued the use of the ISPT JV, a joint venture with the ISPT property fund manager, for Coles' disposals during the year. Future operating lease payments grew from AUD13.8bn to AUD15.2bn during FY14, providing an indication of the scope of the activity.

Retail Price Deflation: The revenue from Wesfarmers' supermarket business, Coles, is exposed to deflationary risks owing to the on-going price-based competition with rival Woolworths. Wesfarmers' supermarket earnings are highly sensitive to fluctuations in its gross margins. However, this risk is mitigated by product inelasticity in the supermarket space and the strong market position of Wesfarmers' retail businesses, which permit a pass-through of the majority of cost increases and also assist Coles in negotiating lower prices from its suppliers.

KEY ASSUMPTIONS
Fitch's Rating Case for the issuer assumes that revenues for FY15 will total AUD62.7bn, with an EBIT margin of approximately 6%. Assumptions for the year also include net capital expenditures of AUD1.7bn and total distributions to shareholders of AUD3.5bn.

RATING SENSITIVITIES
Positive: A rating upgrade is unlikely in the near future as Fitch does not foresee reduction in leverage below the trigger. Future developments that may, individually or collectively, lead to positive rating action include:
- FFO Adjusted Net Leverage (Leverage) reduces to below 2.5x (FY14: 3.32x); and
- FFO Fixed Charge Coverage (Coverage) exceeds 4x;
all on a collective sustained forward-looking basis.

Negative: A rating downgrade may occur should:
- Leverage exceed 3.7x;
- Coverage falls below 2.5x; or
- EBITDAR margin falls below 10%;
all on an individual or collective sustained forward-looking basis.