Sterling slump ramps up pressure on Tesco and British Airways debt, Fitch warns

Clothes retailer New Look, grocer Tesco and British Airways could endure major on their balance sheets and credit rating if the pound continues to slump at current levels, according to a major credit agency.

Fitch said the leverage and credit ratings of New Look and Tesco in particular were at risk from the rising cost of imports as the sterling has tumbled nearly 20% since the start of 2016.

Furthermore, for some companies, the fall of the pound causes a mismatch between the proportions of foreign-currency revenue and debt, which can increase debt-service costs as the pound weakens and if the pound continues to sag, these companies' currency hedging contracts may not provide enough cover, as seen at Sports Direct.

The credit agency's analysis of a 20% sterling depreciation showed that Tesco's unhedged leverage "would rise meaningfully".

"As the country's largest retailer, we believe it will be able to mitigate the impact once hedges expire by sourcing from cheaper locations. But this could increase tensions with suppliers, leading to more disruption such as the retailer's temporary decision to remove Unilever products from its website following a pricing dispute."

While Fitch expected consumers to bear some of the cost of the weakening pound, forecasting CPI inflation to grow 2.8% in 2017 and 2.6% in 2018, retailers will be wary of raising prices as they may lose customers.

"Discussions with suppliers will be tough in the months to come and will demonstrate whether pricing power stays with big suppliers or is shared with large retailers. We expect small domestic suppliers with high exposure to foreign-currency inputs to suffer the most," Fitch said.

For British Airways, which is part of International Consolidated Airlines Group (IAG), the risk arises over the fact that close to 80% of its debt is in foreign currency, versus around half of its revenue.

Other companies may see positive effect, including exporters like Rolls Royce, although Fitch said the potential benefits to its leverage are "limited" and will probably be delayed by hedging contracts.