OREANDA-NEWS. June 16, 2015. Fitch Ratings has revised Gala Coral Group Limited's (GCG) Outlook to Stable from Negative and affirmed the Long-term Issuer Default Rating (IDR) at 'B'. Fitch has also upgraded GCG's subsidiary, Gala Group Finance plc's senior secured notes to 'BB' from 'BB-' and their Recovery Rating to 'RR1'/96%' from 'RR2'. The agency has simultaneously affirmed Gala Electric Casinos plc's senior notes at 'CCC+' with a Recovery Rating of 'RR6'/0%'.

The revision of the Outlook to Stable reflects the improved rating headroom following a good operating profile in financial year to September 2014 (FY14), primarily driven by improved online and bingo operating profits despite the highly competitive market, and the growing Italian business, which we believe will be sustainable. It also reflects our view that the group's business strategy is taking effect. Fitch expects the combination of positive free cash flow (FCF) in 2015 and repayment of propco debt to provide additional financial flexibility in FY15 and beyond.

The 'B' IDR continues to reflect the group's focus on clearly defined business streams. This is offset by the challenging UK gaming environment with strong betting shop and online competition and increasing taxation, regulations and social responsibility requirements, as well as its high leverage which increases the financial risk profile. However, with the election of the new UK government, we expect a more stable approach to UK gaming taxation in the next two years.

KEY RATING DRIVERS
Improved Rating Headroom
The Stable Outlook reflects the improved rating headroom in FY14 and expected for FY15, thanks to turnaround efforts, a strengthening in online operations and the growing Italian business in FY14. Fitch expects positive FCF in FY15, the repayment of property company debt and net disposals of GBP23m in FY14 to provide additional financial flexibility in FY15. This should further improve in FY16 as rising profits from online and bingo generate additional positive cash flow, assuming a more stable tax environment.

Improved Online and Eurobet Trading
Improved Eurobet Italian and online trading allowed EBITDA and the EBITDA margin in FY14 to increase year on year. 1H15 results confirmed the positive trend with group EBITDA rising 10%, on the back of rising online profits (+12% above 1H14). At Coral.co.uk there was strong growth with active players 70% ahead of FY13, driven by successful marketing programmes and a high level of Coral Connect multi-channel sign ups. This demonstrates that management's re-launch plan, begun in 2010, is taking effect.

Competitive Market for Coral
We expect the UK retail environment to remain tough in 2015, although there may be a little respite as competing groups begin to close underperforming stores. Coral UK Retail's FY14 performance was held back by adverse football results resulting in lower gross wins in the UK, and higher operating costs (divisional EBITDA down by 4% on a like-for-like basis), including estate development. This was despite higher machine wins of GBP361m, up 6% and in line with competitors.

Leverage Reduced
Fitch expects FY15 FCF generation, repayment of propco debt and slightly lower capex should lead to a further funds from operations (FFO) gross adjusted leverage reduction, to around 5.6x at FYE15 (from 7.0x FYE14). Gala Coral had a strong cash position, with over GBP200m of readily available cash deposits as at end 1H15.

Bingo Business Stabilising
We expect bingo to improve its operating profit in 2015 as the effects of the reduction in bingo duty come through, while online should continue to perform well. Thanks to a 1% increase in admissions due to the "price smash" sales promotion and lower operating costs (8% lower than FY13) from more efficient staffing, FY14 EBITDA rose 30% to GBP32.9m. This was due to the reduction in bingo duty by 10% and despite the price promotion reducing spending per head (negative 3% in FY14). We believe bingo will be a more stable profit contributor to the overall group relative to FY12-FY14.

Property-Company Debt Repaid
GCG's GBP335m 2005 Propco Three Ltd (PTL) debt due in April 2014 was not repaid and had been in default. This debt was ring-fenced from other group debt, had not triggered a cross-default of GCG's other debt and did not affect the operating company's ability to occupy the properties. All PTL's freehold and long-leased bingo and casino properties have now been sold and the proceeds used to repay most of PTL's debt, the remainder of which has been extinguished via a creditors' voluntary liquidation. Fitch views this and the completed liquidation of PTL as positive for the ratings and has taken this into account when revising the Outlook. We estimate it should reduce FFO lease-adjusted net leverage by 0.5x-0.6x in the next three years.

Enhanced Recovery Prospects for Senior Secured Creditors
The upgrade of Gala Group Finance plc's senior secured notes to 'BB'/'RR1'/96% is due to the enhanced recovery prospects based on the improved EBITDA generated in 2014, based primarily on higher online, Eurobet and bingo operating profits.

We consider that the distressed valuation of the company would be maximised in a going concern scenario, as the business is relatively asset-light. In addition, we believe that should Gala Coral default, this would not be the result of a broken business model, but rather due to a materially adverse regulatory change or unmanageable financial leverage.

RATING SENSITIVITIES
The ratings remain constrained by the competitive UK betting shop and online environment and relatively high taxation regime. However, future developments that could lead to positive rating action include:
-Continued improvement in UK retail, bingo and online operations leading to the EBITDA margin rising to 22% on a sustained basis.
-FFO fixed charge cover rising above 2.5x on a sustained basis.
-Net lease adjusted FFO-based leverage

Future developments that could lead to negative rating action include:
-EBITDA falling below 18% on a sustainable basis (Below 16% where Bingo is sold) resulting from increased competition or additional operational weaknesses.
-FCF shrinking close to zero due to weaker operating performance or unexpected cash outflows.
-Net lease adjusted FFO-based leverage > 6.5x and Gross lease adjusted FFO-based leverage > 7.0x on a sustained basis

KEY ASSUMPTIONS
-UK Retail: Machine gross wins improve in 2015, over-the-counter grows more modestly due to intense competitive pressure and lack of football World Cup in 2015.
-Eurobet Retail: The issue of new licences in 2014 in Italy, combined with the establishment of virtual betting should lead to slightly higher operating profits in 2015.
-Online: We assume online operating profits fall in 2015 due to the new point of consumption (POC) tax, despite new gaming products.
-Gala Retail (Bingo): The strong growth in EBITDA in 2015 will be due to the full year effect of the bingo duty reduction and head office cost savings.
-Capex: We have assumed capex broadly in line with management's assumptions. Capex should rise moderately in 2015 and 2016.
-Propco Debt: With the liquidation of the propco, the related debt amount has been eliminated.