OREANDA-NEWS. Fitch Ratings says that the possible de-merger of the METRO AG (Metro; 'BBB-'/Negative Outlook) group is unlikely to improve the credit profile of either of the new standalone entities in the medium term.

We take a positive view of the split of Metro's food and consumer electronics businesses as this will create two distinct and viable businesses and will enable each management to better focus on the implementation of their own strategy. However, the split does not necessarily resolve the existing operational challenges at both new entities. Pending details of management's revisions to its business plan, if the demerger plan goes ahead, our Negative Outlook on Metro's IDR continues to reflect uncertainties over management's ability to successfully adapt business models to fast-changing consumer habits amid a difficult trading environment.

The future financial structure of each entity remains unknown at this stage. In its preliminary analysis Fitch has assumed a proportional split of debt, cash and operating leases, resulting in similar levels of leverage metrics (adjusted funds from operations (FFO) net leverage of 4.3x in financial year ended September 2015) for each company post-demerger.

Fitch believes that post-demerger Metro's consumer electronics business Media-Saturn is unlikely to remain investment-grade and could see at least a one notch downgrade from the current consolidated group's IDR of 'BBB-'. In addition to the leverage assumption mentioned above, Fitch's assessment will take into account the higher inherent sector and business risk profile of the entity, which is also more aligned with non-food retailers' 'BB' rating category, relative to food retail operations.

Media-Saturn's sector risk profile is fairly high, as growing online shopping is forcing traditional retailers to rapidly adapt their business model, including their store and cost base to withstand this new competition and meet consumers' evolving shopping patterns. In addition geographical diversification will be limited (87% of FY15 sales in western Europe) and the new entity will have low profitability, with a FY15 EBIT margin of 2% before central costs.

In the medium term we do not foresee any significant improvement in Media-Saturn's business risk profile as we expect a large part of the group's investments to be defensive. In the light of uncertain pay-back period from such investments we will likely see rather limited organic growth amid fierce competition. This could hold back any meaningful deleveraging prospects and constrain financial flexibility.

Post demerger Metro's stand-alone wholesale and food specialist group should include the cash & carry business and the Real hypermarkets division. The combined food activities will enjoy a larger scale, a more resilient business model and higher profit margins than the non-food unit (FY15 reported combined EBIT margin of 3% before central costs). However, risks about future operating performance remain. Metro's cash & carry business enjoys good cash generation capacity, yet its exposure to Russia and rouble depreciation (the latter resulting in a diminishing Russian contribution to sales and EBIT) could hamper the food group's recovery in profits and financial metrics.

As we expect most of the proceeds from the divestment of Galeria Kaufhof and Cash & Carry Vietnam to be used for capex and M&A (primarily in the food activities) rather than debt repayment, a meaningful improvement in credit metrics is thus reliant on the successful adaptation of the food retail business model, which entails some execution risks. This is provided that the company also maintains a conservative financial policy. Fitch would expect the maintenance of an EBIT margin of at least 3%, adjusted FFO net leverage trending down towards 4.0x and improved fixed charge (interest plus rents) cover metrics for Metro's food entity to remain an investment-grade company.