UK supermarket giant Tesco announced this week it will buy back up to £700 million pounds of its outstanding debt across a series of its bonds - and then cancel it. Yields fell sharply on the news.
This should surely send a clear signal to rating companies that it is on the path back to an investment grade. The three major firms have Tesco at the highest junk rating with a stable outlook, having dumped it into high-yield territory in early 2015.
It was then in the eye of the storm, having been rocked by an accounting scandal and profit warnings. Chief Executive Officer Dave Lewis has now steadied the ship.
Investor Confidence
Tendering for existing bonds is not an uncommon practice for corporates. Normally it is a tidying-up process involving a buyback of shorter-maturity, higher-coupon bonds and a simultaneous sale of longer-dated securities.
But in this case, Tesco is using its surplus liquidity to cancel the debt. This reduces gearing and strengthens its balance sheet - and gives current investors confidence to drive yields lower.
This buyback looks like a smart long-term move. Tesco may not need to raise debt now, but when it does in the future, having an investment grade rating will no doubt keep its borrowing costs lower. Nice to have, in a world where central banks are tightening policy.
Moody's has already said the buyback is credit positive and would reduce leverage by 0.2 times (it assesses the company's gross leverage at 6.4 times). Music, no doubt, to Lewis's ears.
This is not the first time he has used fixed-income smarts to improve Tesco's footing.
In addition to a bond buyback in June, Lewis also cut the company's sizeable pension liabilities by £700 million. This was partially achieved by switching the discount rate used to calculate the payment obligations from UK government bonds to an index of higher-yielding corporate bonds instead. A higher discount rate lowers the current value of liabilities.
Ideally Tesco's new virtuous circle of debt reduction will offer rewards akin to its famous customer clubcards. Bond investors are already accruing points.
News by Bloomberg, edited by ESM. Click subscribe to sign up to ESM: The European Supermarket Magazine.
