OREANDA-NEWS. Fitch Ratings has affirmed Thomas Cook Group Plc's (TCG) Long-term Issuer Default Rating (IDR) at 'B' with a Stable Outlook. The senior unsecured notes are also affirmed at 'B+'/'RR3'; for both TCG and Thomas Cook Finance plc.

The rating reflects the high risk inherent in the tour operator business, due to competition and the ability to preserve market share. Macro factors such as changing consumer spending habits, economic uncertainty and geopolitical events compound the idiosyncratic risks that TCG is exposed to. High leverage and seasonality of working capital also weigh on the ratings.

In addition to TCG's ongoing turnaround efforts, other factors supporting the ratings are the group's strong brand, leading market position, geographical diversification and scale as well as steadily improving operating performance. However the Stable Outlook balances the improved financial headroom against the increasingly high risks in the tour operator business, particularly structural changes, intense competition and a more uncertain economic outlook within its key end markets.

Management has announced its intention to reduce TCG's fixed-term debt by GBP300m by financial year to September 2018 as well as to commence dividend payments from FY17 (based on 20%-30% of prior year reported profit after tax). Fitch forecasts group-adjusted funds from operation (FFO) gross leverage will trend towards 5.0x by FYE18, excluding the GBP300m announced fixed-term debt reduction. A revision of the Outlook to Positive or an upgrade would be contingent on evidence of a stronger business and financial profile, particularly a more robust business model together with reduced gross leverage.

KEY RATING DRIVERS
Recovery against Heavy Competition
Fitch forecasts group EBIT margins to continue to steadily improve to 4.2% by FY18, helped by slowly recovering end markets, a focused, competent management team and a refreshed product offering.

The ability of TCG to grow margins at a faster rate, in our view, will remain constrained by events and external shocks, dampening the positive impact from self-help measures. We believe that management's target to achieve an EBIT increase of between GBP100m and GBP120m by FY18 under its new customer-focused plan will be difficult to achieve against increasing competition, changing consumer spending habits and cyclicality, which is reflected in the current 'B' rating.

Strong Brand Name
TCG is one of the largest tour operators in Europe, with a well-known and trusted brand, geographic diversification and scale. In Fitch's view, the ability to preserve market share, maintain competiveness and grow top line revenue through differentiated, higher-margin product offerings is a key driver of the rating.

Exposure to External Risks
The tour operator business is vulnerable to changing weather patterns and natural disasters, geopolitical events and reputation risk. Other risks include fuel price, foreign currency and regulation risks, all of which could materially impact profitability and are captured under the current ratings. Such events tend to have a short-term impact, usually in the form of constraining margin uplift. For example the terrorist attack in Tunisia in 2015 reduced TCG's EBIT by GBP22m.

Seasonality and Leverage
Working capital is highly seasonal and typically increases in Q1 of the company's financial year (between October and December) when TCG pays its hotels and other suppliers. Cash balances typically build up in Q3 and Q4 and are paid out in Q1 of the following financial year. For liquidity calculation we set aside GBP1,100m from year-end cash balances as restricted amount, as this is deemed not available for debt service. We expect TCG to continue to have minimum liquidity headroom of GBP200m, which is consistent with the current rating.

Fitch forecasts lease-adjusted FFO gross leverage will trend towards 5.0x by FYE18 (6.4x at FYE15). In calculating Fitch-adjusted gross leverage, we no longer add an amount for working capital as this is captured under restricted cash for liquidity purposes. Instead we now factor in an amount for average gross debt over the financial year, which conservatively takes into account expected drawings under the revolving credit facility of up to GBP200m in Q1 of each financial year.

Above-average Recovery Prospects in Default Scenario
We apply a going-concern approach and assume a post-restructuring EBITDA of GBP382m, and an enterprise value (EV)/EBITDA multiple of 4.5x. Following customary restructuring charges, we estimate recovery of between 51% and 70% for unsecured creditors, resulting in a one-notch uplift for the unsecured bonds to 'B+'/'RR3'.

KEY ASSUMPTIONS
Fitch's expectations are based on the agency's internally produced, conservative rating case forecasts. They do not represent the forecasts of rated issuers individually or in aggregate. Key Fitch forecast assumptions include:

- Steady like-for-like revenue growth, driven by growing volumes in the UK and Nordics, but offset by continued difficulties in continental Europe,
- Slight improvement in EBIT margin to 4.2% by FY18,
- Capex at just over 2% of revenue per year,
- Improving free cash flow (FCF) generation, offset by the resumption of dividend payments from FY17,
- Inclusion of GBP1,100m of restricted cash from year-end cash balances, which we consider not available for debt service.

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
-Improved competitiveness evidenced by increasing revenue and recovered EBIT margin within its divisions, leading to group EBIT margin being above 4% on a sustained basis
-Fixed charge coverage of more than 2.0x (FY15: 1.5x) and lease-adjusted FFO gross leverage (based on Fitch-adjusted calculation of average gross debt) trending towards 4.5x driven by a combination of improved profitability and overall gross debt reduction
-Positive post-dividend FCF on a sustained basis

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
-Deterioration in the group operating margin to below 2.5%, reflecting increased competitive headwinds
-Liquidity headroom below GBP200m
-Increase in FFO-adjusted gross leverage (as adjusted by Fitch) above 6.5x

LIQUIDITY
TCG improved its liquidity during 2015 by increasing its syndicated bank facility to GBP800m (GBP300m for bonding and guarantees) and extending its maturity until 2019. At FYE15, TCG had about GBP200m of readily available cash (Fitch considers GBP1,100m restricted) and there was GBP453m undrawn on the RCF, implying adequate liquidity comfortably above the minimum threshold of GBP200m that Fitch expects TCG to maintain at any one time.

FULL LIST OF RATING ACTIONS

Thomas Cook Group plc
-Long-term IDR affirmed at 'B'; Outlook Stable
-Unsecured notes affirmed at 'B+'/'RR3'

Thomas Cook Finance plc
-Unsecured notes affirmed at 'B+'/'RR3'