OREANDA-NEWS.  Fitch Ratings has assigned Lenta LLC (Lenta) Long-term foreign and local currency Issuer Default Ratings (IDRs) of 'BB-' and a National Long-term rating of 'A+(rus)'. The Outlooks are Positive. A full list of rating actions is below.

The 'BB-' IDR reflects Lenta's strong position in hypermarket food retail segment in Russia and the company's ability to maintain strong operating metrics and profitability, despite accelerated store roll-outs and focus on promotions. In our view, a price-led business model and low share of discretionary non-food items will enable Lenta to maintain healthy like-for-like (LFL) sales growth amid the current economic slowdown. The ratings are supported by Lenta's low leverage and strong financial flexibility.

The ratings are constrained by Lenta's small scale (sixth-largest in Russia), which is commensurate with the 'B' rating category median, and limited diversification outside its core hypermarket format. However, this is balanced by Lenta's consistent market share gains, high opportunities for further growth and lower competition in the fragmented Russian food retail market relative to more mature western Europe countries.

The Positive Outlook reflects Fitch's expectation that Lenta will maintain fast growth pace due to store expansion and positive like-for-like sales growth improving its market position. We note Lenta's deleveraging capacity over the medium term due to the company's strong operating cash flow generation and negative working capital position. Successful execution of the company's growth plans without significant margin sacrifices and evidence of sustainable deleveraging may lead to an upgrade.

KEY RATING DRIVERS
Leading Hypermarket Operator in Russia
The rating reflects Lenta's moderate market position and scale, as Russia's sixth-largest food retailer and third largest large-format operator (after Auchan and Metro) measured by 2014 sales. Lenta's current relatively small size (EBITDAR of EUR439m in 2014) is mitigated by its consistent market share gains, high growth opportunities and relatively low competition compared to developed markets resulting from fragmented nature of the Russian food retail market. A successful execution of its growth strategy will likely solidify Lenta's market position and scale in the 'BB' rating category.

Limited Format Diversification
Despite Lenta's launch of a supermarket format in 2013, we expect the company to remain focused on its hypermarket format over the medium term with supermarkets accounting for less than 10% of sales by 2018 (2014: 3%). At the same time, Fitch views positively Lenta's wide geographic diversification across Russia's regions with a continued reduction in reliance on St. Petersburg market, one of the most competitive in Russia (accounting for 27% of sales in 2014).

Robust Margins Despite Rapid Business Growth
Over the past four years, Lenta has shown a strong track record of fast revenue growth driven by both LFL sales growth and new store roll-outs, while maintaining strong EBITDA margin. However, our rating forecasts factor in a moderate decline in EBITDA margin to 10.0%-10.8% (2014: 11.1%) over the medium term as a result of increasing operating lease expenses and gross margin sacrifices to support its price-led business model. These profitability metrics will remain strong compared with Russian and European food retail peers.

Subdued Consumer Sentiment
Hypermarket operators are usually exposed to higher cyclicality of their business. However, we believe that Lenta's 'value-for-money' proposition, focus on promotions and low share of non-food sales in revenues will enable the company to maintain LFL sales growth in the current period of weak consumer spending, as customers trade down. We expect this consumer behaviour will remain for some time. Erosion of consumer purchasing power should also facilitate customer migration from traditional retail to federal retail chains, including Lenta.

Low Leverage
Fitch expects Lenta's funds from operations (FFO) adjusted leverage to decrease to 3.1x in 2015 (2014: 3.9x) due to RUB12.6bn net SPO proceeds in March 2015 raised by its holding company Lenta Ltd and applied to repay debt and fund expansion at the Lenta LLC level. Although we expect free cash flow (FCF) to remain negative over the medium term due to high capex plans, further deleveraging to 2.8x-2.9x (FFO adjusted leverage) will be supported by growing operating cash flows and maintenance of negative working capital position. We expect Lenta to be able to fund 70%-80% of capex with internally generated cash flows over 2016-2018.

Strong Interest Coverage Metrics
Lenta's FFO fixed charge cover (2014: 2.6x) is strong relative to Russian peers as a result of high proportion of owned selling space and thus relatively low operating lease expenses. Despite the increased cost of funding and planned growth of leased space due to new supermarket openings, we expect FFO fixed charge coverage to remain strong for the rating.

Average Recoveries for Unsecured Bondholders
Fitch has assigned a senior unsecured long-term rating to Lenta's rouble bonds in line with its 'BB-' Long-term local currency IDR, reflecting average recovery expectations in case of default. We have not applied any notching to the senior unsecured rating compared with the Long-term IDR as prior-ranking debt constitutes less than 2x of group EBITDA and we expect the debt mix to remain over the rating horizon.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Annual revenue growth of close to 30% driven by high single-digit LFL sales growth (driven both by traffic and basket growth) and selling space CAGR of 20% over 2015-2018
- EBITDA margin decreasing to around 10.0%-10.8% as a result of increasing share of leased space in store portfolio and margin sacrifices
- Capex at around 9%-11% of revenue
- No external dividends paid by Lenta Ltd funded by Lenta LLC.
- Neutral to negative FCF margin
- No large-scale debt-funded M&A

RATING SENSITIVITIES
Negative: Future developments that could lead to a revision of the Outlook to Stable from Positive include:
- Slowdown in store roll-outs, deterioration in like-for-like sales performance relative to close peers reflecting a challenging operating environment or materialisation of execution risks in its growth strategy.
- No evidence of sustained deleveraging, based on FFO adjusted gross leverage (2014: 3.9x).

Future developments that could lead to a downgrade include:
- A sharp contraction in like-for-like sales growth relative to close peers along with material failure in executing expansion plan.
- EBITDA margin erosion to below 7% (2014: 11.1%).
- FFO-adjusted gross leverage above 4.5x on a sustained basis.
- FFO fixed charge cover below 2.0x (2014: 2.6x).
- Deterioration of its liquidity position as a result of high capex, worsened working capital turnover and weakened access to local funding.

Positive: Future developments that could lead to positive rating action include:
- Solid execution of its expansion plan and positive like-for-like sales growth relative to peers leading to improved market position in Russia's food retail sector.
- The ability to maintain the EBITDA margin at around 9%.
- FFO-adjusted gross leverage below 3.5x on a sustained basis.
- FFO fixed charge coverage around 2.5x on a sustained basis.

LIQUIDITY AND DEBT STRUCTURE
As at end-March 2015, Lenta's liquidity position was adequate. Unrestricted cash of RUB7.8bn and cash balance of RUB8.8bn at Lenta Ltd level (with most of it downstreamed to Lenta during the second quarter) together with available undrawn credit lines (RUB7.3bn) were sufficient to cover expected negative FCF and RUB9.5bn short-term debt.

Although we acknowledge Lenta's growth-led model, even if we assumed a substantial deceleration in the expansion programme post-2015, the group would generate positive FCF in the low to mid-single digits of sales, which would be strong for the rating, therefore mitigating any refinancing risks.

FULL LIST OF RATING ACTIONS

Long-term foreign currency IDR assigned 'BB-', Positive Outlook
Long-term local currency IDR assigned 'BB-', Positive Outlook
National rating assigned 'A+(rus)', Positive Outlook
Senior unsecured rating assigned 'BB-'/RR4
National senior unsecured rating assigned 'A+(rus)'