"The downgrade follows Carrefour's weak 2011 trading performance with a 19% drop in its current operating income and the group's ongoing challenges to improve the competitive profile of its French and Italian hypermarkets," says Johnny DaSilva, Director in Fitch's Corporate team. With lease-adjusted net debt(excluding its services operations) to EBITDAR ratios of 3.3x (3.1x before exceptional), Carrefour's leverage is line with a 'BBB' rating. The key challenge for Carrefour remains the successful execution and improvement of its operations in France, notably in its large hypermarket stores and the stabilisation of group's operating profit in Europe. After putting on hold the roll-out of its Planet stores, Fitch understands that the new management team is now focused on fixing the basics (adjusting price, reducing promotions, sorting out the product assortment, reducing inventories turnover, launching commercial initiatives) to lure customers back to its stores. However, Fitch also notes ongoing price pressure in the food retail industry in Europe due to government austerity measures, high unemployment rate as well as intense competition in the non-food segment from specialist retail chains and the development of internet shopping. The group remains mainly exposed to a weak consumer environment in Europe (72% of group sales), notably in southern countries such as Italy, Spain, Greece which represent about 20% of group sales. These concerns are mitigated by the group's organic growth in emerging markets, notably in Brazil and China. Fitch views positively Carrefour's more cautious financial strategy, as evidenced by the reduction of the group's dividend payout ratio and the focus on cash flow with strict capex discipline. Fitch expects a gradual improvement in Carrefour's metrics over the next 18 months. The company's liquidity remains adequate, with cash and equivalents at end-December 2011 of EUR4.8bn and EUR3.25bn in undrawn credit facilities maturing in 2012 and 2015 with no financial covenants. The rating could improve with evidence of a recovery on Carrefour's performance in its core French market in terms of sales growth, market share, operating profit and subject to group's operating margin rising above 3.3% (2.7% as of FYE11). In terms of credit metrics, for an upgrade, Fitch would expect Carrefour's adjusted net debt to EBITDAR ratio to return to a range of 2.5x-3.0x. Negative pressure on the rating could occur if the group's operating margin is below 2.5%, the group's lease-adjusted net debt to EBITDAR ratio increases to 3.5x or if the group initiates any further shareholder-friendly measures over the next 18 months. Fitch could upgrade the Short-Term rating to 'F2' if Carrefour meets the agency's 'Short-Term Rating Criteria for Non-financial Corporates' (dated January 2012 at www.fitchratings.com), two out of three internal liquidity ratios and notably FCF/EBITDAR >20% and FFO/debt service ratios >1.5x. (source: reuters.com)