Marcus Ashworth is a Bloomberg Gadfly columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

U.K. supermarket giant Tesco Plc announced this week it will buy back up to 700 million pounds ($921.6 million) 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.

Buyback Candidate
The longest-dated of the Tesco bonds in the tender moved sharply lower in yield on news of the buyback
Source: Bloomberg

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.

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.

Road To Recovery
Tesco credit default swaps have marched in as its recovery story takes hold
Source: Bloomberg

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.

Tesco Tidy-Up
Tesco is offering to cancel two of its longest-dated bonds with its buyback
Source: Bloomberg DDIS function
Bars show amount outstanding at each year

Moody's Corp. 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 pounds. This was partially achieved by switching the discount rate used to calculate the payment obligations from U.K. 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.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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Marcus Ashworth in London at

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