OREANDA-NEWS. Fitch Ratings has downgraded Waste Italia SpA's (WI) Long-Term Issuer Default Rating (IDR) to 'C' from 'CC'. Fitch has also affirmed the senior secured notes' rating at 'C'. The Recovery Rating of the notes is 'RR5'.

The downgrade follows the company's announcement that it will not pay the EUR10.5m coupon on the senior secured notes due on 16 May 2016, thus entering a grace period of 30 days.

The downgrade also reflects expected stressed liquidity throughout 2016, a decline in landfill capacity below our rating guidelines, weaker operating performance with assumed further delay in new capacity due to permitting and funding constraints and recent management change. WI has also produced a more conservative business plan for 2016-20.

Although parent company Gruppo Waste Italia SpA (GWI) provided bridge financing to help meet the coupon payment on WI's senior notes in November 2015, GWI's planned merger with indebted Biancamano S.p.A in 2017 may affect shareholder support over the longer term.

Debt Restructuring Due
Uncured expiry of the 30 day grace period following the company's missed payment of the 16 May 2016 coupon on its secured notes or non-payment of the mandatory cash repayment of EUR5m on 29 May 2016 would result in a downgrade of the IDR to 'RD' (Restricted Default).

Having appointed financial advisors Banca Leonardo in association with Houlihan Lokey in February 2016, WI is negotiating with the bondholders committee a strategic review of its capital structure. The advisors have completed a review of the business plan, but the review of the capital structure is unlikely to be completed before December 2016.

Stressed Liquidity
Fitch estimates that WI had cash, overdraft facilities and unused factoring lines totalling EUR8m-EUR9m as at 20 April 2016. The company also needs to make a mandatory cash repayment of EUR5m to holders of the senior secured notes due at the latest on 29 May 2016. WI and its advisors are currently negotiating with investors a potential waiver of the mandatory cash repayment, as owner of 44% of GWI, Sostenya Group plc, had purchased EUR5m of the notes in October 2015. However, the repurchased bonds were not cancelled, the legal conditions for a waiver are unclear and we do not assume that the repurchase will offset the repayment.

Liquidity is likely to remain stressed throughout 2016 with an additional coupon payment of EUR10.5m and a potential, currently non-binding, acquisition of Lafumet Servizi Srl for EUR3.5m, both due in November 2016.

Decline in Landfill Capacity
The useful life of WI's remaining landfill capacity at end-2015 of 3.246mn cu m has fallen to 3.4 years, slightly below our negative rating guideline of 3.5 years. Unless new capacity is authorised, capacity would be exhausted before the maturity of the EUR200m bond in November 2019. The most important extension project, Chivasso3/Wastend, passed the initial stage of the permitting process in November 2015, but permitted additional capacity has been lowered by nearly 30% to 750,000cu m. In view of stressed liquidity, Fitch believes that funding capex for projects such as Chivasso3 remains challenging beyond ordinary annual maintenance capex of EUR11m.

Weaker Operating Performance
The Italian market for waste treatment is highly fragmented, putting competitive pressure on small sized companies in a context of weak GDP growth, which broadly characterised WI's waste collection activity in 2015.

WI's cash EBITDA in 2015 fell 35% yoy to EUR34m. Based on slower growth in collection volumes and softer pricing, including landfill, we have lowered 2016-18 annual EBITDA estimates by an average of 25% in March 2016. This also reflects our view that, given permitting and funding constraints, new capacity is delayed by a year at Chivasso3 to 2018 and at Verde Imagna to 2019. This is a more conservative assumption than management's. Based on more competitive pricing, WI has produced a more conservative business plan for 2016-20 than its predecessor in April 2015.

Management Change, Corporate Governance
CEO Enrico Friz resigned in January 2016, and was replaced by Flavio Raimondo, the third CEO in a year. It remains to be seen if further management change has an impact on this year's results. GWI's plans to merge with Biancamano, which will not trigger the change of control covenant in WI's senior secured notes, have been postponed to end-2016.

Post-merger, GWI has plans for a capital increase of EUR10m-EUR30m. However, given that net debt at Biancamano is currently EUR114m (versus 9M15 EBITDA of EUR5.9m), Fitch believes that a more heavily indebted parent company may be in a weaker positon to provide WI with financial support in the future. However, Biancamano's debt is due to be restructured before the merger.

Fitch's key assumptions within the rating case for WI include:
- Additional landfill capacity is delayed at Chivasso 3 to 2018 (from 2017) and at Verde Imagna to 2019 (from 2018)
- Collection volumes grow at an annual average of 3% for 2016-19 vs. 4.5% or 2015-18
- Average prices of EUR108/t in 2016 and EUR112/t in 2017, slightly below our previous estimates, on continued competitive pressures
- Adjusted EBITDA margins of 30% in 2016, before declining as high-margin landfill capacity
falls until 2018, when Chivasso3 comes on-stream, restoring margins to 30%-34%

Negative: Future developments that could lead to negative rating action include:
-Uncured payment default on the senior secured notes' coupon or on the mandatory cash repayment.

Positive: Future developments that could lead to positive rating action include:
- Improved liquidity and recurring earnings leading to a more sustainable capital structure and payment of the due coupon and mandatory cash repayment.
- Sustained operational improvement, including timely landfill permitting as planned.
- Expected funds from operations (FFO) adjusted net leverage sustainably below 5.5x and FFO interest coverage above 2.0x