S&P: Turkish Appliance Manufacturer Vestel Affirmed At 'B-'; Outlook Stable
The affirmation reflects Vestel's solid operating performance over the past 12 months, driven by strong revenue growth in both its TV and white goods markets, combined with an expected EBITDA margin (as adjusted by S&P Global Ratings) of about 6.0% for 2016, up from 5.4% in 2015. However, this is offset by Vestel's continued reliance on short-term debt financing, in part due to sizeable intragroup lending (Turkish lira [TRY] 900 million [about USD 310 million] as of June 30, 2016) to its parent Zorlu Holding. About 82% of Vestel's gross financial debt of TRY3.1 billion was due within one year as of June 30, 2016, which exposes the company to refinancing risks. Although we expect Vestel's short-term debt will decline over the next 12 months, primarily due to working capital inflows and debt refinancing, we expect that its cash balances and operating cash flow will not fully cover short-term debt and capital expenditures (capex). As a result, we have revised our liquidity assessment to weak from less than adequate.
Our assessment of Vestel's business risk profile continues to reflect its volatile operating margins and cash flow generation, largely because of fierce competition and uneven demand in the consumer electronics sector. It also incorporates our view of high country risks in Turkey, such as economic, institutional, financial market, and legal risks that arise from doing business in or with Turkey. That said, Vestel's market share in liquid crystal display (LCD) TV sales in Europe has increased over the past several years, and the company has become the largest B-brand producer of LCD TVs in Europe. Vestel has gradually increased its market share in the domestic white goods market, As of June 30, 2016, its market share stood at 15%, up from 13% in 2014. However, the company still largely depends on its key suppliers, which we see as another main weakness in Vestel's business risk profile.
Our assessment of Vestel's financial risk profile primarily incorporates its high S&P Global Ratings' adjusted gross debt to EBITDA and strong reliance on various forms of short-term financing. In addition, we expect the company's credit ratios and cash flow generation will remain highly volatile because it is exposed to demand swings and its margins and revenues are vulnerable to currency fluctuations. This is partly offset by our expectations of modest positive free operating cash flow (FOCF) and solid cash interest coverage ratios of between 2.5x and 3.0x in 2016-2017.
The stable outlook on Vestel reflects our view that the company is likely to reduce its short-term debt over time, primarily following working capital improvements, active refinancing of short-term domestic bank loans, and reduced lending to Zorlu Holding. In addition, we expect Vestel will generate at least break even FOCF in 2016-2017.
We could lower the rating if Vestel experienced declining revenues and margin prospects due to weaker demand or tighter availability of consumer financing in Turkey, adverse currency swings, or heightened competition. In particular, S&P Global Ratings' adjusted EBITDA margins sustainably below 4% and significantly negative FOCF for more than 12 months, coupled with a continued weak liquidity, could trigger a downgrade.
A positive rating action on Vestel would hinge on an EBITDA margin consistently above 6%-7%, an adjusted debt leverage ratio of below 5x at year-end, and sustainably positive FOCF of more than TRY100 million per year. We do not see adequate liquidity as an absolute requirement for a one-notch upgrade, but the likely full coverage of liquidity uses, such as capex and short-term debt, throughout the fiscal year would be a key consideration for raising the rating.