Fitch Affirms Zalar Holding at 'B(mar)'; Outlook Stable
The rating affirmation results from the ongoing recovery in Zalar's operating results and key financial metrics after two years of extreme market conditions, in line with our expectations. The group should be able to maintain a financial profile in line with the National Long-Term Rating of 'B(mar)' due to its solid competitive position and the consolidation of its business profile following a heavy investment phase. This is despite our expectation of some market volatility beyond 2016 and supports the Stable Outlook.
The rating continues to reflect the legacy of an aggressive capital structure leading to high refinancing risk, with meaningful deleveraging remaining largely contingent on benign market conditions. The group also only benefits from restricted financial flexibility, with limited liquidity and weak funds from operations (FFO) fixed charge cover.
KEY RATING DRIVERS
Strong Recovery in Results
In its conservative financial forecasts, Fitch expects Zalar to reach record high EBITDA of at least MAD300m in 2016. This comes after two years of depressed results resulting mostly from competitive disruptions, either due to lack of organisation in highly fragmented markets or due to low barriers to entry in some others.
The high profit should result from a normalisation of competitive behaviour in the trading and animal feed segments (as a number of companies exited and prices have recovered), and high prices in the poultry-related sub-sectors following the avian flu outbreak at the beginning of 2016 and a heatwave that further reduced global poultry production in the summer.
Reinforced Business Model
Fitch does not expect the 2016 market conditions, and therefore Zalar's 2016 EBITDA, to be sustainable over the longer term, as they are partly the result of temporary circumstances. However, we believe the group's EBITDA resilience has improved following the heavy investment in 2014-2016, making it able to better resist market fluctuations. Therefore the rating reflects our view of the sustainability of Zalar's business model. This is due to its now greater scale and deeper vertical integration resulting in synergies, improved technical yields and better control over margins, notably in its downstream activities.
Assuming average market conditions over 2017-2019, Fitch forecasts that the group could have annual EBITDA generation of more than MAD230m, supported by higher production capacity and market shares, and an EBITDA margin that should now be sustainable at 6%.
High Refinancing Risk
We do not expect the combination of extremely adverse events of 2014 and 2015 to be repeated, although market conditions will likely remain volatile. This together with its reinforced business model should enable Zalar to keep readily marketable inventory (RMI)-adjusted FFO gross leverage below 8.0x (20x in 2015 and 27x in 2014) over 2016-2019, i. e. at a level which is more commensurate with the assigned 'B(mar)' Long-Term National Rating.
However, Fitch's assessment also factors in limited deleveraging capacity under average market conditions. Under these assumptions, Fitch forecasts Zalar's RMI-adjusted FFO gross leverage could remain high at around 7.8x in 2018, reflecting high ongoing refinancing risks.
In 2015 the group's liquidity was supported by Seabord Corporation's MAD176m equity injection as a new shareholder. Furthermore, Zalar's majority shareholder (together the Chaouni family and Greenlight, the acquisition vehicle the family created to acquire Zalar's shares as part of the buy-out in 2011) negotiated the postponing of Greenlight's own scheduled debt service from November 2015 to January 2016, making possible the deferral of the payment of MAD145m dividends that Zalar had declared for the year.
Over the rating horizon (2016-2019) Fitch expects Zalar's free cash flow (FCF) to remain volatile despite increasing EBITDA generation, lower capex from 2017, confirmed VAT refunds totalling MAD180m over 2016-2018 and assumed marginal acquisition activity. This reflects Zalar's aggressive capital structure resulting in high interest costs in proportion to its EBITDA generation capacity and the repayment of Greenlight's debt (which remains outside Zalar's consolidation perimeter) through recurring dividends combined with volatile working-capital needs.
Fitch expects the group's internal liquidity score (RMI plus unrestricted cash plus account receivables, divided by current liabilities) to remain weak over the next four years at around 0.7x, implying a recurring need for external funding sources. However, Fitch believes Zalar should be able to consistently roll over its short-term debt due to its demonstrated comfortable access to bank financing.
Limited Financial Flexibility
We expect Zalar's RMI-adjusted FFO fixed charge cover (adjusted for the share of dividends paid by the group used to service debt at Greenlight) to recover from the trough levels of 0.4x in 2014 and 0.7x in 2015, which had resulted from record-low profits. We forecast the ratio to improve to 1.1x-1.3x over the next four years, a level adequate for the rating.
We view positively Zalar's ability to conserve cash by deferring dividend payments in 2015, but we believe the group's shareholders may have a limited set of additional protective measures should market conditions strongly deteriorate again.
Structural Subordination for Holding Creditors
The MAD350m bond issue is an unsecured, unguaranteed debt obligation of Zalar. Bondholders do not have direct recourse to the main operating companies' assets or profits but only an unsecured claim on intercompany loans in those opcos. The bond rating of 'CCC+(mar)' with expected recoveries between 0% and 10% ('RR6') reflects structural subordination for bondholders relative to creditors at subsidiary level.
Weak recovery prospects are exacerbated by the presence of large senior or secured liabilities at opco level, which rank senior to holding company creditors, even though we believe liquidation could provide greater recoveries than a sale of the business under going concern in a hypothetical event of default.
Fitch's key assumptions within the rating case for Zalar include:
- Stable revenues in 2016, growth in the high single digits over 2017-2019 as a combination of higher volumes (demand growth, capacity expansion) and selling prices normalisation
- EBITDA margin peaking at 8.3% in 2016 due to unusually high gross margins, stabilising at 6%-6.3% over 2017-2019.
- Substantial working-capital inflows in 2016 due to lower grain and animal feed prices, outflows in line with growing sales thereafter
- MAD94m capex in 2016 due to the final phase of Zalar's investment programme (building of animal feed plant started in 2015), moving towards maintenance level over 2016-2019
- Repayment of shareholder's short-term loan of MAD145m, of which MAD115m in 2016 and MAD31m in 2017; annual common dividend of MD75m to MAD80m over 2017-2019
- MAD50m acquisition spending in 2016 on a rail-connected terminal in Fez. We assume an annual MAD20m budget for bolt-on acquisitions thereafter
- Liquidity supported by access to renewable bank lines and an about MAD105m new loan to fund capacity expansion and acquisitions
Positive: Developments that may, individually or collectively, lead to positive rating action include:
- Improvement in profitability measured as RMI-adjusted operating EBITDAR/ gross profit above 40%, together with FCF returning to break-even or positive, underpinning internal liquidity - cash plus RMI plus account receivables divided by total current liabilities - of more than 0.5x (excluding committed bank lines).
- RMI-adjusted FFO fixed charge cover (including apportioned dividends to cover Greenlight's debt service) above 1.2x (2015: 0.7x).
- FFO adjusted leverage below 7x (RMI-adjusted FFO leverage below 6x) for more than two consecutive years.
Negative: Developments that may, individually or collectively, lead to negative rating action include:
- Weak profitability (EBITDA margin under 3% or RMI-adjusted operating EBITDAR/ gross profit below 30%) along with recurring negative FCF, reflecting a slower-than-expected market recovery or continuing large working capital or capex outlays necessitating increasing external financing.
- Weak internal liquidity of less than 0.5x (excluding available bank lines).
- RMI-adjusted FFO fixed charge cover (including apportioned dividends to cover Greenlight's debt service) of 1.0x or lower on a sustained basis.
- FFO adjusted leverage of more than 8x (RMI-adjusted FFO leverage greater than 7x) for more than two consecutive years, reflecting an increasingly unsustainable capital structure.
- In connection with the maturity of the IFC's put option in October 2018, the absence of an IPO or of a trade buyer for IFC's stake, a debt-financed buy-back of IFC's stake by Zalar.
Zalar depends on the availability of working-capital financing as it is still mainly a grain processor and trader despite growing vertical integration. This leads to high short-term debt relative to its total debt. At end-2015 its liquidity was relatively weak as Fitch-adjusted unrestricted cash balances of MAD59m and estimated liquid inventories and receivables (RMI) of MAD514m together with MAD908m available undrawn short-term facilities were just sufficient to cover Zalar's short-term debt of MAD1.3bn.
FULL LIST OF RATING ACTIONS
Zalar Holding SA
-National Long-Term Rating: affirmed at 'B(mar)'; Outlook Stable
-Unsecured bond national rating: affirmed at 'CCC+(mar)'/'RR6'