Argentina's Electronics Retailers

Amid a Growth Surge, Plenty of Risks Remain
Revenue growth will be strong in 2012 but retailers still face risks, from economic volatility to the short tenor of financing
» Strong revenue growth will continue for Argentina’s electronics retailers. The sector is poised to increase revenue in the mid double digits – around 50% -- in 2011 and 2012, compared with an average 60% in 2010, extending the sharp rebound from the downturn in 2009. Government subsidies for consumer loans, low-cost funding for the retailers and Argentina’s economic expansion have been key drivers for the sector.
» Argentina’s national government will remain supportive. A government-sponsored installment payment scheme for consumer electronics products implemented in 2010 was a positive for retailers, as was the 2010 World Cup soccer event, which stimulated sales of LCD televisions. The more flexible payment plans rolled out by banks and retailers translated into meaningful revenue and earnings growth. We expect the current administration to continue supporting consumption.
» Retailers face several risks. Despite strong growth and solid government support, the Argentine electronics retailers continue to face risks that are reflected in their single-B credit ratings. These include dependence on short-term financing for liquidity, the challenging operating environment in Argentina (high inflation, interest rate risk, political risk, and economic volatility), and small scale and limited geographic diversification in comparison with global peers. Further, rapid growth has required large investments in new store openings and working capital that have absorbed cash.
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SPECIAL COMMENT: ARGENTINA'S ELECTRONICS RETAILERS: AMID A GROWTH SURGE, PLENTY OF RISKS REMAIN
Strong Revenue Growth Set to Continue
Argentina’s electronics retail sector is in the midst of an explosive growth period that we expect to continue in 2012. The sector has grown revenue at a compound annual rate of 18% since 2007. Following a recessionary slowdown in 2009, revenue growth rebounded to an average of 60% in 2010, helped in part by strong demand for LCD televisions around the 2010 World Cup soccer event. Growth this year and in 2012 will remain robust in the mid double digits as the drivers that stimulated a demand surge in 2010 remain in place.
We forecast revenue growth of more than 50% for the retailers this year. From here, we think revenue growth will be slower, but it will handily surpass Argentina’s GDP growth rate during the next few years. (Moody’s Macroeconomic Board currently forecasts GDP growth in Argentina of 7.8% this year and 4.3% in 2012.)
FIGURE 1
Revenue Growth for Rated Argentinean Retailers 2007 to 3Q11
Company
Revenue 2007 (USD mill)
Revenue LTM (USD mill)
Reporting Date for LTM
CAGR %
Fravega S.A.
539.9
956.8
Sep-11
16%
Garbarino S.A.
779.3
1,460.9
Jul-11
18%
Carsa S.A.
161.3
283.0
Aug-11
16%
Electronica Megatone S.A.
172.2
352.6
Aug-11
21%
Total
1,652.7
3,053.3
18%
Argentina’s economic expansion and good availability of consumer credit have been key drivers of this growth. The Argentine economy is showing brisk expansion despite the economic stagnation in the advanced economies. Government support has aided the country’s consumer credit expansion, which raises the question as to the sustainability of this demand driver.
The sector leaders, Garbarino S.A. (B1 stable) and Fravega S.A. (B1 stable) in particular, have benefitted from these trends. Garbarino realizes the most revenue per store, as shown below, as a result of its presence in select locations in key cities, coupled with strong merchandising and customer service.
FIGURE 2
Revenue per store
(USD million)
Source: Moody’s
-2 4 6 8 10 12 14 2007200820092010Fravega S.A. Garbarino S.A. Carsa S.A. Electronica Megatone S.A.
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These companies have also benefitted from government tax policy. Both are vertically integrated operators with manufacturing and financing arms. In November 2009, the Congress raised the internal taxes on imported electronic products to 20.48%, far above the 7.01% tax rate for local manufacturers in Tierra del Fuego, Argentina. This, along with other modifications to the system of excise taxes, was intended to protect local producers from foreign competition. Imported goods have been reduced, allowing local producers such as Fravega and Garbarino to enjoy increasing volume growth.
Government support a key driver for the sector
Government support for an expansion of consumer credit has helped fuel revenue growth for retailers. Retailers are driving sales through both private-label credit cards and government-subsidized consumer loans that allow for low-interest installment payments. The government is also helping support the sector through the state-run Banco de la Nacion Argentina, which now offers five-year credit facilities/loans to these companies at 9.9%, a very low interest rate in an environment of 20%-plus inflation. We expect the current administration to maintain these supports for consumption and the retailers.
FIGURE 3
Evolution of consumer credit
Source: Central Bank
Strength in the Argentine economy is also benefitting the retailers. In recent years, consumers have enjoyed rising purchasing power amid low unemployment rates. Expansionary fiscal and monetary policies have pushed inflation to an estimated 25% in 2010 and 2011 from 15% in 2009. In turn, real interest rates have been negative, which discourages consumers from saving money.
Risks Accompany Retailers’ Rapid Growth
Despite 18% compound annual revenue growth since 2007 and strong competitive positions in the domestic market, the retailers continue to face several risks that constrain their credit ratings.
The Argentinean retailers face large capital investments to boost capacity to meet rising demand for LCD TVs, digital cameras and air conditioners. Investments in new store openings and working capital have led to negative cash flow from operations (CFO) and free cash flow (FCF) . Expansion is likely to drive leverage modestly higher and to have a continued slightly negative effect on free cash flow during the next couple of years. The relatively modest increase in leverage should not be too
0246810121416-10,000.0 20,000.0 30,000.0 40,000.0 50,000.0 60,000.0 200320042005200620072008200920103Q-11Banking System's Personal Loans Stock (ARS mill)Interest rate (BADLAR -Annual avge)
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much of a problem for these companies if supportive government policies remain in place. This appears likely for now: Substitution of imports with domestic goods is a major policy position for President Cristina Fernandez de Kirchner, who easily won reelection to a four-year term on Oct. 23.
Another challenge is the short-term tenor of most of the retailers’ debts. The retailers depend on banks to roll over their credit lines. Access to the local bond market is limited in duration (generally 12- to 18-month instruments) and amount (there are limits to funding availability). Retailers with credit card operations are dependent on the securitization market to monetize their credit card receivables. Because of these exposures, a disruption of the credit markets could affect the liquidity of the retailers fairly quickly.
An additional challenge is the high risk in the operating environment for business in Argentina. Our sovereign rating on the Government of Argentina (B3 stable) incorporates risks associated with its policy mix and actions. Further, Argentina’s economy has traditionally been volatile, so there is a continuing risk to retailers of sudden declines in demand for consumer electronics.
The rated retailers are also constrained by the sector’s relatively small size and limited geographic diversification, with exposure exclusively in Argentina. Although they have solid positions in the Argentine market, they are relatively small compared with global peers and are limited by operating in a single country. Garbarino, the largest of the four rated retailers, has annual revenue of $1.4 billion, a tiny fraction of players like Best Buy Co. ($49 billion) and RadioShack Corp. ($4.8 billion).
Appendix A – Rating Methodology Factors
Moody’s approach to rating Argentinean retailers is based on the Global Retail Industry rating methodology. The following are the four key factors and how the Argentinean retailers rank.
Factor 1: Business and Cash Flow Volatility (10.0% Weight)
Company
Moody's CFR
Grid-Indicated Sub-Factor Rating
Moody's NSR
Outlook
Segment Vulnerability to Changes in Consumer Demand
Fravega S.A.
B1
B
Aa2.ar
Stable
B
Garbarino S.A.
B1
B
Aa2.ar
Stable
B
Carsa S.A.
B3
B
A2.ar
Stable
B
Electronica Megatone S.A.
B3
B
A2.ar
Stable
B
Revenue and cash flow volatility represent key business risks for any corporate issuer. For retailers, revenue and cash flow volatility are particularly important given their significant fixed operating costs, potentially meaningful seasonal variations in working capital, and price competition due to the ease with which consumers can compare prices.
The rated Argentinean retailers primarily operate in the consumer electronics and home appliances business segment, with cash flows vulnerable to economic cycles and product renewal risk or technology shifts. These retailers are more stable than specialty retailers, but not as stable as hypermarkets. This sub-factor is scored the same B category for the four rated retailers, as they operate in the same segment.
Factor 2: Market Presence (25.0% Weight)
Company
Moody's CFR
Grid-Indicated Sub-Factor Rating
Moody's NSR
Outlook
Scale (Revenue in USD Billion)
Market Concentration and Company's Presence in that Product Category
Company Geographic Presence
Fravega S.A.
B1
B
Aa2.ar
Stable
$1.0 / Caa
Ba
Baa
Garbarino S.A.
B1
B
Aa2.ar
Stable
$1.5 / Caa
Ba
Baa
Carsa S.A.
B3
B
A2.ar
Stable
$0.3 / Caa
Ba
Ba
Electronica Megatone S.A.
B3
B
A2.ar
Stable
$0.3 / Caa
Ba
Ba
A company’s market position is an important part of its ability to withstand adverse credit events. Scale, market concentration, and geographic presence are three important components when assessing a retailer’s market position.
The largest players can access more and cheaper financing, and they have greater potential for leveraging operating costs and supplier pricing. Market presence and geographic diversification help limit cyclical earnings volatility.
Fravega and Garbarino are the most diversified retailers with countrywide presence. However, despite having recognized brand names and strong market presence in different product categories, they do not have a leading market presence in any.
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Factor 3: Execution Ability (15.0% Weight)
Company
Moody's CFR
Grid-Indicated Sub-Factor Rating
Moody's NSR
Outlook
Quality of Execution
Efficiency: EBIT / Avg. Book Capitalization (Net of Cash)
Fravega S.A.
B1
Baa
Aa2.ar
Stable
Ba
24.9% / Aaa
Garbarino S.A.
B1
Baa
Aa2.ar
Stable
Ba
21.5% / Aa
Carsa S.A.
B3
Ba
A2.ar
Stable
Ba
17.6% / A
Electronica Megatone S.A.
B3
Baa
A2.ar
Stable
Ba
25.5% / Aaa
A retailer's business is ultimately about providing consistent access to the right products, in the right locations, at the right time, and with the appropriate value proposition with which the customer can identify and feel comfortable.
The sub-factor “Ba” execution quality reflects the retailers’ well-established relationships with suppliers. For example, Fravega’s enhanced quality of execution is based on the group's fully vertically integrated operations, comprised of an appliance production plant based in Tierra del Fuego, which is one of its main suppliers. Additionally, the group operates Banco Saenz (B2 positive), which grants personal consumer loans to Fravega's customers.
Factor 4: Financial Ratios (50.0% Weight)
Company
Moody's CFR
Grid-Indicated Sub-Factor Rating
Moody's NSR
Outlook
Debt / EBITDA
RCF / Net Debt
EBITA / Interest Expense
Fravega S.A.
B1
Ba
Aa2.ar
Stable
2.9x / Baa
22.0% / Ba
3.5x / Ba
Garbarino S.A.
B1
Baa
Aa2.ar
Stable
2.9x / Baa
22.4 / Ba
4.2x / Baa
Carsa S.A.
B3
Baa
A2.ar
Stable
2.3x / A
38.9% / A
5.2x / Baa
Electronica Megatone S.A.
B3
Ba
A2.ar
Stable
2.7x / Baa
15.9% / Ba
3.4x / Ba
All of the financial metrics incorporate Moody’s standard adjustments. Debt incorporates all adjustments that we customarily make to debt figures, including operating leases using the larger of 8x of rent expense or the present value of future minimum rent, and other off-balance-sheet arrangements deemed to be debt-like, such as securitizations.
Financial ratios matter because they can show that two identical retailers in terms of business and financial policies may exhibit radically different credit profiles. We utilize metrics that measure both the absolute capacity of the issuer to service its debt, and the size of the debt burden relative to that of peers.
The Argentinean retailers’ fast growth during the last couple of years has required large investments in new store openings and working capital, leading to negative cash flow from operations (CFO) and free cash flow (FCF). Notwithstanding strong activity levels in recent years, the companies have been able to achieve strong credit metrics for their rating categories.
Other rating considerations not reflected in the grid
Operating environment: With revenues entirely generated from sales in Argentina, retailers are vulnerable to the ups and downs of the local economy. The retail industry is particularly sensitive to inflation and interest rates affecting consumer purchasing power. Increased domestic interest rates could impact the industry’s performance.
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Operating model: The “normal” retail model calls for retailers to buy merchandise from suppliers, offer it for sale to consumers, and profit from the difference between their resale price and their purchase and operating costs. Retailers may increase or reduce business risk by engaging in different operating models:
Carsa S.A. (B3 stable) and Electronica Megatone S.A.’s (B3 stable) retail finance model enhances profitability as measured by EBIT margins, but also includes significant credit exposure to consumer loans extended through Megatone's own financing source. These companies rely on the securitization market to fund these operations. Because of these exposures, a disruption of the credit markets could affect the liquidity of the retailers fairly quickly.
EXHIBIT 1
Revenue Breakdown by means of payment
Based on retailers’ Securitizations Terms and Conditions
Source: Comision Nacional de Valores (www.cnv.gob.ar)
On the other hand, Fravega is a fully vertically integrated operating company with production, commercialization and financing of its operations, and well-positioned retail stores across the country (53% owned stores).
Liquidity: Liquidity is particularly critical for retailers, whose normal operations cause large seasonal swings in cash patterns. Weak liquidity, which may be a result of financial policy or an unexpected event that interrupts normal inventory liquidation, magnifies default risk.
Over the last few years, the main sources of liquidity for local retailers have been funds from operations, short-term bank lines and Local Notes issuance. These companies generally lack committed credit facilities. In 2011, the companies benefitted from Banco de la Nacion Argentina credit lines. These lines bear attractive interest rates and longer terms than traditional private credit lines.
45%54%78%78%55%46%22%22%0%20%40%60%80%100%120%CarsaElectronica MegatoneFravegaGarbarinoCash + Commercial Credit CardsOwn Credit
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Appendix B – Company profiles
Fravega (B1 //Aa2.ar // Stable ) is one of the largest home appliance retailers in Argentina. With total revenues of ARS 3.9 billion (USD 1.0 billion) and 4,800 employees as of the 12 months ended September 30, 2011, Fravega is a family-owned company with a widely known brand name in the local retail market. The company is one of the largest dedicated retailers of consumer electronics and appliances in Argentina, with solid market position in selling recognized brand names and enjoys very well-established relationships with suppliers. The ratings are based on the group’s fully vertically integrated operations, comprised of an appliance production plant based in Tierra del Fuego, which is one of its main suppliers, and Banco Saenz (B2 stable), which is responsible for granting personal consumer loans to Fravega’s clients.
Garbarino (B1 //Aa2.ar // Stable) was founded in 1951 and has developed into a well-known brand name in the local retail market. It is one of the largest home appliance retailers in Argentina. With total revenues of ARS 5.6 billion (USD 1.5 billion) and 5,800 employees as of the 12 months ended July 31, 2011, Garbarino’s B1 rating reflects its brand strength, dominant position in the Argentinean retail market, solid credit metrics and diversified product lines. The rating also takes into consideration the positive impact on its receivables portfolio from the use of third-party credit cards where the risk of default is borne by the card issuer rather than the retailer.
Carsa (B3 //A2.ar // Stable) is a leading regional appliance retailer operating 98 stores in twelve provinces. It had total revenues of USD 283 million during FY ended in August 2011. The company was founded in 1977 and is one of three retailers licensing the “Red Megatone” brand name in Argentina. Carsa’s ratings are underpinned by its position as one of the main dedicated consumer electronics and appliance retailers in Argentina. The ratings reflect the well-developed diversification of its product line, which has allowed Carsa to increase its share of the consumer’s wallet, and solid credit metrics for its rating category. The ratings also reflect Carsa’s solid position in selling recognized brand-name home appliances and its well-established relationships with suppliers. Carsa’s key credit negatives include the particularly challenging business model given the weak retail profitability and significant credit exposure for the consumer loans extended through Megatone card, issued by Carsa. Moody’s notes that Carsa’s credit business segment has been the principal earnings generator and has been funded by the securitization market. Moody’s will closely monitor Carsa’s ability to continue to access the securitization funding vehicle. as well as its strategic plans for the Musimundo retail chain, after obtaining Musimundo's brand name licensing. Carsa's relatively small scale, limited geographic diversification and the competitive environment also constrain the ratings.
Electronica Megatone (B3 //A2.ar // Stable) Headquartered in Santa Fe province, Argentina, Electronica Megatone is a leading regional appliance retailer operating 100 stores across twelve provinces. With total revenues of USD 353 million as of FY ended in August 2011, it is one of the three retailers licensing the "Megatone" brand name in Argentina. The B3 and A2.ar ratings are supported by the company's position as one of the main dedicated consumer electronics and appliance retailers in Argentina, operating under the Megatone brand name. The ratings reflect EM's diversified product mix, low adjusted leverage and its well-established relationships with suppliers. The ratings also consider EM’s strong revenue growth and improved operating margins. EM's key credit negatives include its retail finance model, with significant credit exposure to consumer loans extended through Megatone's own financing source. Moody's notes that EM's consumer credit segment has been the principal earnings generator and has been funded by the securitization market. Moody's will closely monitor the company's ability to continue to access the market for securitization financing, as well as its strategic plans for the Musimundo retail chain, after obtaining Musimundo's brand name licensing. EM's relatively small scale, limited geographic diversification and the competitive environment also constrain the ratings.
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Report Number: 138160
Author
Veronica Amendola
Production Specialist
Wendy Kroeker