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S&P cuts Tesco outlook to negative on profit fears

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Standard & Poor's has cut its outlook on Tesco to negative in the belief declining profitability may force it to cut the UK retailer's credit rating in future.

Tesco’s performance will “continue to be dampened” by weak consumer spending in the UK, S&P said, adding that competition pressures in the UK may more than offset the benefits of the retailer’s global diversification.

The ratings agency suggested Tesco’s efforts to improve its standing among customers could hit margins in future.

“We believe that the commitment by Tesco management to invest in improving customer service and experience levels in its UK stores will also negatively affect its trading margins,” S&P said in a statement.

Last month, Tesco revealed that like-for-like sales, excluding both VAT and petrol, dropped 1.5% during its first quarter to May 26.

S&P said the outlook could be moved back up to stable if Tesco reduces its debt through selling businesses or “succeeds in turning the currently negative operating trends around and establishes reasonable headroom under its key financial metrics”.

But the ratings agency warned Tesco’s credit rating, which it has affirmed at A-/A-2, could be cut if the retailer did not act to stem its current problems.

“We would likely lower the ratings if Tesco’s current ‘excellent’ business risk profile were to weaken due to a sustained fall in its UK market share, declining sales growth in its international operations, or a failure to turn around currently visible trends of declining profitability,” S&P said.

The agency said a downgrade was likely if debt to EBITDA (earnings before interest, taxes, depreciation and amortization) rose higher than 3.5x, up from a current level of 1.3x.

The shares were not affected by the downgrade, standing at 320p, up 0.5% in late afternoon trading.

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