The agency said the new rating reflected Moody's expectation that over the intermediate term Bass "will actively pursue sizeable acquisition opportunities and/or enter into material repurchases of its own shares." It said that while recent divestments such as the sale of its breweries and the disposal of 988 pubs "have resulted in a strengthening of the financial profile, over the longer term both the financial and business risk profile of the company are expected to weaken, from a debt holders perspective, as Bass pursues the expansion of its hotel operations in particular."
After the sale of the breweries and pub, the group will be "effectively debt free and its financial profile very strong," Moody's said. However, it continued: "In spite of this conservative financial profile Moody's has decided to lower the ratings, as in our view, Bass will continue not only to invest heavily in the organic expansion of its existing hotels business, by leveraging off its existing brands to build its franchised and managed hotel network, but also by acquiring new hotel properties and possibly other hotel operators.
The rating downgrade also recognises the possibility that if Bass fails to identify ongoing attractive business opportunities in which to invest, then the company is likely to come under increasing pressure to pursue more material share buy-backs over the intermediate term, Moody's said.
However, the financial house said, "it should also be noted that Bass continues to perform well and benefits from strong management. It has recorded steady improvements in operating margins in recent years, its businesses exhibit improving geographical diversification and both its hotel and leisure retail operations include a broad array of recognisable brands. While the sale of the brewing operations has removed a stable but low growth cash generative business, this divestment combined with the continued expansion of the international hotel business, has led to an improved geographical distribution of earnings and a reduction in the company's reliance on the buoyancy of the UK economy.
The company's hotel operations currently contribute around half of its operating profit, with the remainder coming from the leisure retail business and its stake in Britvic. Bass says it has successfully integrated the Inter-Continental acquisition, has demonstrated a solid
record of brand development and in our opinion it also benefits from a relatively low concentration of hotel operating income (measured by % of total operating income contributed by its top 10 hotels).
The hotel portfolio is "currently well balanced between owned and leased hotels, and managed and franchised hotels, although we expect the balance to increasingly shift towards owned and leased hotels over the intermediate term," Moody's said. It believes that the cash flow generated by owned and leased hotels is more volatile and less predictable than that generated by management contracts or franchises, and as a result we expect the group to become more susceptible to economic and cyclical downturns over time. However, the upscale nature of many of Bass PLC's owned hotels and their desirable locations, often in gateway cities where supply can be constrained, may provide some degree of protection against falling revenues in the event of an economic downturn.