Credit Insights 01/22: Optical retailers – poor working capital management drives leverage up

Our portfolio of rated optical retailers includes the industry’s three largest Croatian companies – Ghetaldus Optika, Optotim, and Servus (better known under its brand Optika Anda). At the end of 2020, Ghetaldus Optika was a market leader with sales of HRK 141,3m and 88 stores, followed by Servus with sales of HRK 87,7m and 39 stores, and Optotim with sales of HRK 35,1m and 14 stores.

The pandemic has hit optical retailers’ top line, but flexible cost structures and Covid measures alleviated the impact

Optical retailing industry was hit by the pandemic, mostly due to lockdowns and limited store accessibility during the pandemic measures. Customers also often postponed non-urgent treatments and shied away from visiting stores which are normally located in the most affluent locations. While Ghetaldus Optika and Optotim suffered from a 17,1% and a 18,8% drop in sales in 2020, respectively, Servus managed to contain the top line with a 0,7% decrease due to its sizeable investments in store openings.

Despite the negative impact of the pandemic on the companies’ top line, EBITDA was hit only mildly, with Ghetaldus Optika even recording a slight increase from HRK 29,8m in 2019 to HRK 31,0m in 2020. Optotim recorded a decrease from HRK 7,0m to HRK 6,5m, while Servus’s EBITDA decreased from HRK 32,5m to HRK 31,2m. The three largest optical retailers have shown their resilience in terms of profitability mostly due to their flexible cost structures (i.e., a high portion of variable costs), in addition to the government support measures that were put in place during lockdowns.

Poor working capital management drives leverage up

All three leading players exhibit poor working capital management scores in our rating assessment. As per chart below, the very long inventory days are the main driver of the working capital financing gap, which stems from a weak inventory turnover and high seasonality of merchandise driven also by fashion risk. The three rated companies employ different strategies to manage the gap. Namely, Ghetaldus Optika relies on the combination of its suppliers and short-term debt to support its working capital financing. However, Optotim relies fully on suppliers, therefore exhibiting much higher risk as payables days exceed seven months on average. Finally, Servus finances its working capital gap largely by equity, and has receivables days matched with its payables days.

Since we apply the adjusted debt principle, similar to leading credit rating agencies, we have adjusted the debt of Ghetaldus Optika and Optotim for the trade payables in excess of industry-wide standards. We consider any financing with payment terms above 90 days akin to debt. Therefore, at the end of 2020, the debt of both Ghetaldus Optika and Optotim has been increased by HRK 12,0m (the same amount is a pure coincidence!).

Limited reported debt, yet high debt adjustment for operating leases

All three rated companies report financials under the Croatian Financial Reporting Standards (CFRS), hence their financials were not affected by the recent change in reporting of operating leases as stipulated under IFRS 16. Again, since we apply the adjusted debt principle, we have adjusted the debt level of the rated companies for operating leases by using the 5x rent cost multiple, similar to the approach of the Moody’s rating agency.

The amount of reported debt remained modest, largely due to absence of collateral as the business model of optical retailers relies on leasing rather than owning their stores.

The chart below shows the rated optical retailers’ debt structure, with clear leading share of capitalized operating leases.

We think the recovery has already started but intensifying competition, weak liquidity and large investments will constrain optical retailers’ ratings

Given the relaxation of the pandemic measures, we think that the recovery has already started in 2021 and will continue in 2022. FCF generation will be under pressure, as fight for market share continues. Counterintuitively, Ghetaldus Optika and Servus increased their CAPEX spending to record levels already in 2020. Still, the market remains largely fragmented, with limited growth potential and moderate barriers to entry. We think the largest companies will continue to grow organically by opening new stores and taking over market share from smaller players utilizing their brand reputation, quality of service, and broader product offering. We believe that ratings of Ghetaldus Optika and Optotim will remain constrained due to weak liquidity, while Servus’s rating development will largely depend on the magnitude of its store openings plan and how such plan will impact the company’s capital structure.

For more information about creditworthiness of optical retailers, feel free to get in touch by e-mail to mario@creditanalyst.eu, the contact form on https://creditanalyst.eu/en/contact/, or call us on +385 98 920 17 13.