Correction: Fitch Affirms Orange at 'BBB+'; Outlook Stable
Fitch Ratings has affirmed Orange S. A.'s Long-Term Issuer Default Rating (IDR) and senior unsecured rating at 'BBB+'. The Outlook is Stable. A full list of ratings actions is below.
The ratings are supported by the strong domestic operations of Orange in France, which accounted for around 60% of the group's restated EBITDA minus capex in 1H16, and by a leverage position that is comfortably within its 'BBB+' rating. Investments in broadband networks, price increases and opportunities for cost reduction are enabling the group to offset revenue declines driven by structural and regulatory changes in the sector, weakness in Poland and the loss of wholesale revenues in France.
However, increases in capex will continue to restrain cashflow generation and organic deleveraging capacity over the medium-term, assuming no change in the dividend policy.
KEY RATING DRIVERS
Domestic Operations on Stable Footing
Investments in broadband networks and focus on convergent products are leading to improved operational metrics with Orange's market shares of broadband lines and mobile service revenue stabilising, by our estimates, at around 41% and 42% respectively at end-1Q16. We expect that promotional offers will continue to exert competitive pressure on the market, driven by Iliad's desire to build scale in mobile and Bouygues's aim to increase market share in fixed broadband. However, these pressures, in our opinion, are likely to be incremental, with minimal impact on Orange's operating margins.
Wholesale Loss More Gradual
Orange France will lose wholesale revenues over the next five to six years. The loss of revenues that typically carry higher EBITDA margins than the group average, will be driven by three different sources. Firstly the migration of Iliad's mobile roaming traffic to the company's own network as it is being expanded; secondly the migration of SFR's fixed unbundled lines (LLU) to Numericable; and the loss of LLU lines generally as Numericable/SFR, Bouygues and Iliad build out their own fibre to the home. We expect the loss of wholesale revenues to be more gradual than originally forecast.
Orange has recently extended its mobile national roaming agreement with Iliad until 2020 and the rate of uptake of fibre among the broadband customer base of Numericable/SFR, Bouygues and Iliad, which drives the loss of LLU lines, has been slower-than-expected. The more gradual loss provides greater scope for the company to offset EBITDA declines through cost reduction, potential price increases and improved competitive position. Orange has an ambition to make gross cost savings of EUR3bn over 2015 to 2018 which if achieved, are likely to be sufficient to offset the loss of wholesale revenues and potentially the ongoing impact of competition.
International Operations Contribute to Growth
In 2015, Orange's operations in Spain and Africa & Middle East (A&ME) accounted for 16.0% of restated EBITDA minus capex, with other European operations (including Poland and Benelux) accounting for 12.7%. We expect free cash flow (FCF) contribution from Spain and A&ME to increase to around 20% over the next five years, improving the group's cashflow diversification. The increase reflects consolidation synergies from the acquisition of Jazztel in Spain and acquisitions and organic growth in A&ME. We expect contribution from other European markets to decline slightly, largely as a result of weakness in operations in Poland.
Solid Leverage for Rating
Orange's funds for operations (FFO)-adjusted net leverage at end-2015 was broadly stable at 3.3x. This reflects stabilising trends in FCF, combined with use of hybrids to fund acquisitions. Orange's 2015 leverage was at the lower end of its immediate peer group of Fitch-rated 'BBB+' large, geographically diversified European telecoms operators: Telefonica (3.7x), Deutsche Telekom (3.7x) and Vodafone (3.4x). We expect Orange's leverage to reduce further in 2016 to 3x, supported by EUR4.5bn proceeds from the sale of EE.
FCF to Remain Constrained
Capex is likely to remain elevated over the next three to four years, driven by spectrum payments, fibre roll-out in France, potentially lower fibre co-investment (following SFR's acquisition by Numericable) and Orange's commercial strategy to build robust and market - leading broadband networks across its European operations.
Fitch estimates that Orange's capex spend, excluding spectrum, will increase to around EUR7bn in 2016 from EUR6.5bn in 2015. The increase corresponds to a capex-to-sales ratio of 17%. The increase is likely to be sustained over the next two to three years and will weigh on FCF generation, with pre-dividend FCF margins unlikely to exceed 5% during this period.
Fitch's key assumptions within our rating case for the issuer are:
- Revenue growth of 1.5% in 2016, largely reflecting organic and acquisition growth in Spain and A&ME, partially offset by declines in France and weakness in Poland. Revenue growth of between 0.2% and 1% thereafter.
- Group restated EBITDA margins of 31% in 2016, gradually increasing to 32% over the next three years.
- Capex-to-sales ratio (excluding spectrum) of 17% - 17.5% per year.
- Broadly stable dividends in line with 2015 at EUR1.6bn per year.
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Expectations of FFO-adjusted net leverage trending below 2.5x on a sustained basis
- Improved competitive position in Orange's domestic and other key international markets combined with growth in pre-dividend FCF.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- FFO-adjusted net leverage trending above 3.5x on a sustained basis, which would lead to a downgrade.
- Pressure on FCF, driven by continued EBITDA erosion, higher capex and shareholder distribution, or significant underperformance in the core domestic market and at other key subsidiaries.
FULL LIST OF RATING ACTIONS
Orange S. A.
- Long-Term IDR: affirmed at 'BBB+'; Outlook Stable
- Senior unsecured: affirmed at 'BBB+'/'F2'
- Short-Term IDR: affirmed at 'F2'
- Commercial paper programme: affirmed at 'F2'
- Subordinated undated notes: affirmed at 'BBB-'