CREDIT OPINION Dufry AG Update Following Year End and Interim Results Update Summary Rating Rationale Dufry's Ba3 rating reflects Dufry's (1) leading market position with around 24% market share of the airport travel retail spending according to the company (2) strong geographical footprint; (3) track record and know-how in operating a travel retail business; (4) expectation of long term positive organic sales growth in line with growth of passenger air traffic. RATINGS Dufry AG Domicile Switzerland Long Term Rating Ba3 Type LT Corporate Family Ratings - Dom Curr Outlook Stable Please see the ratings section at the end of this report for more information.the ratings and outlook shown reflect information as of the publication date. Contacts Ernesto Bisagno 4420-7772-5403 VP-Senior Analyst ernesto.bisagno@moodys.com Marina Albo 44-20-7772-5365 MD-Corporate Finance marina.albo@moodys.com The rating is however constrained by the (1) high leverage reflecting Dufry's aggressive acquisition strategy; (2) the execution risk associated with the integration of World Duty Free ( WDF ) (3) the cyclical nature of the company's travel retail business, which is tied to international passenger traffic, with an exposure to certain discretionary items (e.g., perfumes and cosmetics, confectionary and luxury goods); (4) risks associated with the renewal of concession contracts as well as to certain event risks that would have implications on global travel behaviour. Positively, we expect Dufry's metrics to strengthen with adjusted leverage to decline towards 4.7x in 2016 down reflecting the full contribution from WDF and additional combined synergies from Nuance and WDF coming on stream, as well as return to positive organic growth, as guided by management. Exhibit 1 Dufry's Leverage To Decline From Fiscal 2015 High Adjusted (gross) debt/ebitda Source: Moody's Investors Service estimates
Credit Strengths Leading travel retail operator Diversified revenue base by product and by geography Positive free cash flow generation Solid profitability compared to Moody's-rated specialty retailers Credit Challenges Sales development correlated to international passenger flows Exposure to event risk High leverage driven by the company's aggressive acquisition strategy Execution risk from the integration of WDF Rating Outlook The stable outlook reflects our expectations that Dufry's credit metrics will improve as a result of the full contribution from WDF combined with positive organic growth. With leverage to decline towards 4.7x in 2016, we expect the company to start building headroom within the rating category. Whilst there is still some execution risk from the acquisition of WDF, management indicated that the initial phase of integration started well. Factors that Could Lead to an Upgrade Upgrade pressure on the ratings would reflect Dufry's ability to restore positive organic growth and successfully integrate WDF with EBITDA (on a reported basis) margin strengthening above 12.5% and debt/ebitda (fully adjusted for the concessions) trending towards 4.5x, on a sustainable basis. Factors that Could Lead to a Downgrade Conversely, downward pressure on the rating would reflects operational weakness or difficulties in integrating the acquired assets. Quantitatively, downward pressure could be exerted on the ratings if Dufry's financial leverage does not return below 5.25x and RCF / net debt does not improve to 14% by the end of 2016. This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history. 2
Key Indicators Exhibit 2 Detailed Rating Considerations LEADER OPERATOR WITH A WELL-DIVERSIFIED BUSINESS PROFILE Dufry has grown its position within the global travel retail industry through a combination of organic growth, new concession contracts and acquisitions. Dufry operates over 2,200 shops in airports (89% of sales), downtowns (5%), railways (4%), and cruise liners (2%). The acquisition of WDF, the second largest operator in the travel retail industry, further consolidated Dufry`s leading position in the travel retail market. Following the acquisition of WDF, Dufry increased its share of airport travel retail to approximately 24%. Dufry has a fairly diversified business profile with a global presence across continents and formats. The company operates across 63 countries in 370 locations. Concentration risk is manageable with the largest contract accounting less than 6% of total sales and the top 10 contract below 25%. Moreover, Dufry operates various store formats encompassing general travel shops, news agents and convenience stores, and brand boutiques. The company's stores sell a wide assortment of products including perfumes, cosmetics, confectionary, wines and spirits, tobacco, and accessories. Although the company is exposed to certain discretionary product categories (e.g., perfumes and cosmetics, confectionary and luxury goods), its good geographic and product diversification should help cushion any severe contraction in sales in any category or in any region. SALES GROWTH CORRELATED TO INTERNATIONAL PASSENGER FLOWS Dufry's travel retail operations are correlated to international passenger flows, and are, therefore, subject to a degree of cyclicality. Positively, passenger flows have continued to grow steadily around 5% per annum and only in 2009 it registered a decline with volumes falling 1.5%, according to the Euromonitor. Global air passenger growth in 2015 was driven by better demand from the Middle East and Asia Pacific as well as Latina America, as well as a steady growth in Western Europe and North America. Despite weak economic conditions in some the regions (particularly Russia and Brazil) overall global traffic has been robust in 2015. 3
Exhibit 3 Passenger Flows have been historically resilient with a decline on in 2009 on the back of the global recession Passenger Growth over 2005-2017 Source: Euromonitor In 2015, Dufry reported a negative growth rate of -5.3% due to the negative impact from Brazil and Russia; excluding Brazil and Russia, organic growth was +4.0%. More positively, organic growth started to improve in Q4 2015 with the trending continuing in Q1 2016 due to a combination of stabilization in Russia and Brazil and easier comparable with last year. Including the contribution from WDF (consolidation from August 2015) and Nuance (12 months contribution), the company reported revenue growth of 46.4% and EBITDA up 25.5% for the full year. In Q1 2016, including the contribution from WDF, reported revenue/ebitda increased by 60%/59.2%. Organic growth improved with a decline of -5.2% compared to -6.5% in Q4 2015. ORGANIC GROWTH TO RETURN POSITIVE IN 2016 In 2016, the company targets organic growth around 3.0%-4.0% due to the contribution from the refurbishment plan across its stores improving the sales density and opening of new space; that would be combined with the easing of the headwinds from Brazil and Russia. In the medium term, the company guides organic growth in the 5%-7% driven by passenger growth (3%-4%), spending growth (1%-2%), and contribution from new concessions (1%-2%). Whilst it would be higher than the 2016 rate, we note that Dufry has historically reported strong organic growth rate of 8% between 2005-2013. In the longer term, we believe that Dufry's growth should be driven by a continued increase in passenger flows, both domestic and international, especially to and from the Middle East and Asia. However, its business can be affected by certain events, such as terrorist attacks or natural disasters which might lead to a sudden and severe decline in passenger volumes for a period of time. DUFRY MAINTAINS A DIVERSIFIED REVENUE BASE The diversified revenue base mitigates the exposure to disruptions related to adverse local or regional economic or political events and the renewal of concession contracts in key markets. Positively, the company has a strong track record with approximately 90% of retention rate for the expired contracts. Average life of the existing concessions is 8.5 years. The acquisition of WDF further enhanced the combined group's geographical footprint, providing it with a balanced geographic portfolio that holds strong positions in mature and emerging markets. WDF's portfolio strengthened Dufry's position in Europe and North America and expanded the geographical footprint in the Middle East and Asia. GOOD PROFITABILITY IN LINE WITH DEPARTMENT STORES With an EBIT margin (fully adjusted) of 11.2% at FY 2015, Dufry's profitability is in line with the rated UK departments stores (Debenhams Plc Ba3 stable 11.1% and House of Fraser (UK & Ireland) Limited B3 stable 13.7%) and higher than Macy's, Inc. (Baa2 stable) with an EBIT margin of 8.9%. 4
Although Dufry's profitability continue to benefit from higher-return emerging markets, the acquisitions of WDF had a negative impact on margins given the higher exposure to developed markets (64% of EBITDA generated from the developed markets at FY 2015 compared to 47% in FY 2013). However, the lower exposure to emerging market, will limit forex headwinds and exposure to political risk as well as to less stable economic environments. In addition, the company's concession-based business model is considered to be more flexible than that of a traditional retailer because concession fees are mostly variable, whereas rents tend to be mostly a fixed charge. Therefore, operating margins are less likely to be eroded as sharply when footfall and sales slow-down. CREDIT METRICS TO STRENGTHEN OVER 2016-17 We expect margins to improve over 2016-17 driven by the synergies from acquired assets and a positive organic growth. Management indicated that the integration of Nuance is completed with a total achieved synergies of CHF70 million of which CHF36 million will be reflected in 2016. Management also confirmed the original guidance of EUR100 million synergies from the integration of WDF by 2017 with first synergies expected in the second half of 2016. Around EUR50-60 million include cost synergies and EUR40-50 million related to gross margin improvement reflecting the optimization of commercial policies and enhanced purchasing power. Whilst there is still some execution risk, management indicated the initial phase of the integration of WDF is progressing on track. Leverage peaked at 2015 at 5.6x due to the acquisition of WDF which only contributed 5-months during the year. We expect Dufry to deleverage in 2016 down to 4.7x reflecting stronger earnings with full contribution from WDF and additional combined synergies from the acquired assets coming on stream and our assumption of a debt prepayment of CHF400 million. We model further improvement in leverage towards 4.1x over 2017-18 driven by positive organic growth in line with management long term guidance. With small shareholder distributions and a modest level of capex at 3% of total sales, we expect the free cash flow generation to strengthen. Whilst historically the company has been very acquisitive, we expect management will focus on organic growth and deleverage and we expect a positive free cash flow of CHF400-500 million per annum over 2016-17 which we assume to be largely utilized to pay down debt. Despite the positive free cash flow, we expect gross adjusted debt to increase as a result of higher concession costs going forward which we assumed to increase in line with sales growth. The adjustment for concession fees (CHF1,597 million in 2015), which we view as a proxy for rental expenses, accounts for the large majority of gross debt. Capitalized concession fees adjustment, adds approximately CHF8 billion to Dufry's gross debt in 2015 and will increase to around CHF11 billion (using a 5x multiple) in 2015 reflecting additional rental expenses from the full contribution from WDF. Positively, we note that Dufry mostly operates under concessions with variable payments based upon the revenues of each shop which provides Dufry a more flexible debt structure when compared to the typical retailer. However, some concessions also include a fixed fee component called "MAG" which would be payable to the airport operator regardless of the amount of sales generated from the shop. Liquidity Analysis Dufry's liquidity is good, underpinned by cash balances of CHF483.5 million (31 March 2016) and a CHF900 million RCF maturing in June 2019 (CHF718 million undrawn at 31 December 2015); and our expectation of ongoing positive free cash flow generation supported by the absence of dividends and a moderate level of capital expenditure. We note that the first quarter is seasonally the weakest for the company with Dufry having its strongest season of turnover and EBITDA between July and September corresponding to the summer time in the northern hemisphere. During 2015, the company fully refinanced the bridge loans funding the acquisition of WDF through a combination of rights issues of EUR2.1 billion, a new term loan of CHF800 million and a bond issuance of EUR700 million. Dufry will not have any material debt maturities until June 2019 when around CHF1.8 billion bank facilities would mature. Existing financial covenants as amended in January 2016, include a max net debt/ Adj. EBITDA threshold of 4.50x (to be reduced to 4.25x in June 2016, to 4.00x in December 2016 and to 3.75x in March 2017) and Adj. EBITDA / Adj. interest expenses interest covenant 5
threshold to 3.5x. As of 31 March 2016, Dufry maintained ample headroom under its financial covenants (more than 50% for the interest cover and around 15% for the leverage). Structural Considerations Dufry's Ba3 senior unsecured instrument ratings are in line with the corporate family rating (CFR). This reflects the lack of significant subordination with all the obligations benefiting from a guarantee from Dufry AG, Dufry Financial Services B.V. and the subsidiaries that collectively represent 100% of the consolidated net assets and EBITDA of the company. However, these instruments rank behind a small amount of secured debt and trade payables located at the operating subsidiaries' level. Profile Headquartered in Basel, Switzerland, Dufry AG is a leading global travel retailer with operations in 63 countries. Dufry operates over 2,200 shops in airports (89% of sales), downtown (5%), railways (4%), and cruise liners (2%). The acquisition of WDF, the second largest operator in the travel retail industry, further consolidated Dufry`s leading position in the travel retail market. Following the acquisition of WDF, Dufry increased its share of airport travel retail to approximately 24%. Dufry's network includes general travel retail shops, `walk-through' shops, brand boutiques, news agents and convenience stores with a product offer spanning perfumes & cosmetics, wines & spirits, tobacco, watches & jewellery, and accessories. Dufry is listed on SWX Swiss Exchange with a market capitalization of CHF6.4 billion and a free float of 77.6%. At 31 December 2015, there is a syndicate led by the long-term shareholder Travel Retail Investments, an holding company owned by Mr Andrés Holzer Neumann (vice-chairman of Dufry), amounting to 22.4% Rating Methodology and Scorecard Factors We expect the company to start building headroom in the Ba3 rating reflecting full contribution from WDF and return to positive organic growth combined with the synergies coming on stream. With the integration of WDF at the initial phase, there is still some execution risk constraining the rating. 6
Exhibit 4 Credit Metrics to strengthen over the next 12-18 months Source: Moody s Financial Metrics Ratings Exhibit 5 Category DUFRY AG Outlook Corporate Family Rating -Dom Curr Moody's Rating Stable Ba3 DUFRY FINANCE S.C.A. Outlook Bkd Senior Unsecured Stable Ba3/LGD4 Source: Moody's Investors Service 7
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