Fitch Rates Votorantim Cimentos' Proposed Unsecured Notes 'BBB-(EXP)'
At the same time, Fitch has assigned VCSA a Long-Term Local Currency Issuer Default Rating (IDR) of 'BBB-'/Negative Outlook and a National Scale Rating of 'AAA(bra)'/Stable Outlook. Fitch currently rates VCSA's LT FC IDR 'BBB-'/Negative Outlook as well. A full list of ratings follows at the end of this release.
The Negative Outlook on VCSA's IDRs reflects the company's high leverage ratios and the challenging economic environment in Brazil, which has resulted in a swift deterioration in domestic sales volumes. Fitch projects net leverage to remain high in the range of 4.8x-5.1x during 2016 and 2017, declining only to below 4.0x in 2018.
The decision by Brazil's antitrust authority, CADE, to impose a BRL1.6 billion fine on VCSA and the forced sale of certain assets for alleged cartel practices poses further uncertainty for the company over the coming years. VCSA, along with the other cement companies charged, have appealed the sanctions in the Brazilian courts. During 2015, VCSA was awarded an injunction suspending CADE's ruling until a final judgment is reached. We expect the appeals process could likely take several years.
KEY RATING DRIVERS
Credit Linkage with Parent
Votorantim Cimentos is a key operating subsidiary of Votorantim S. A. (Voto) (LT FC IDR 'BBB-'/Negative Outlook), accounting for approximately 50% of Voto's EBITDA and 72% of its net debt as of June 30, 2016, per Fitch's calculation. As of June 30, 2016, 31% of VCSA's total debt had guarantees from its parents (Voto and Hejoassu Participacoes S. A.). Voto has clearly stated that VCSA is an important wholly owned subsidiary and would provide cash to the company if necessary, through equity support or debt assumption.
VCSA is currently rated one notch above Brazil's Country Ceiling of 'BB+'. Besides the linkage with a stronger parent, others factors that mitigate sovereign transfer and convertibility risk include having approximately 49% EBITDA generation outside of Brazil, a large cash balance in the U. S. and USD700 million of revolving credit availability until 2020.
Severe Contraction in Brazil's Cement Market to Persist
The Brazilian cement market declined by 8.8% to 65.2 million tons in 2015 from 71.5 million tons in 2014 due to a slowdown of infrastructure projects and bagged cement sales amidst the contraction in the country's economy. Through the six months ended June 30, 2016, volumes declined 14% to 28 million tons from 33 million tons for the prior year period. Fitch expects cement volumes in Brazil to remain subdued, at around 55 million tons for 2016. Recovery of cement volumes will likely occur by 2018, but growth in volumes will be sluggish and Fitch projects cement volumes to remain below the level sold in 2014 for at least the next four years.
Weakening EBITDA Generation in Brazil
Fitch projects VCSA's EBITDA generation to be around BRL2.5 billion for 2016 compared to BRL3.2 billion for 2015 and BRL3.5 billion in 2014. This decline results from the sharp decline in volumes sold and limited price increases and cost reduction initiatives during the year in Brazil. Fitch envisions VCSA's capacity utilization rate in Brazil to remain around 55%-60% over the next two years compared to the 88% rate the company experienced in 2014. VCSA's strong market share of 35% with its 28 plants and 34.5 million tons of installed capacity across the country and its international diversification mitigates some of the risks faced by small regional players.
Leverage to Remain High
Fitch expects VCSA's net leverage to remain elevated as the company completes its heavy investment cycle amid the demand slowdown in its key market, Brazil. Per Fitch's calculation, VCSA had net leverage around 4.6x for the LTM ended June 30, 2016 compared to 4.7x for year-end 2015. Fitch projects net leverage to remain high, in the 4.8x-5.1x range during 2016 and 2017, declining only to below 4.0x in 2018. Fitch believes VCSA has limited-to-medium ability to accelerate its deleveraging through the sale of non-core assets and other contingency plans which the company has in place.
Fitch's key assumptions within the rating case for the issuer include:
-- High single-digit consolidated volume decline in 2016 and low single-digit consolidated volume increases in 2017 and 2018;
--Brazil's volumes decline around 15% in 2016 with limited recovery until 2018;
--Low mid-single-digit volume growth in other key markets such as North America, Europe, and Africa during 2016 and 2017;
--Consolidated EBITDA margin falling to 18%-20% during 2016 and 2017;
--Capital expenditures of BRL2 billion in 2016 and BRL1.4 billion in 2017, declining thereafter following completion of expansion projects;
--Net leverage to remain high around at 5.0x in 2016, considering Fitch's methodology;
--Maintenance of strong liquidity position and proactive liability management strategies in order to avoid refinancing risks in the next two to three years.
Considerations that could lead to a negative rating action on the rating or Outlook:
VCSA's foreign currency ratings could be downgraded further if the macroeconomic conditions in Brazil result in cement volumes declining more than Fitch's expectations for 2016, resulting in pressure on credit metrics beyond a tolerable level. A return to through-the-cycle net leverage around 2.5x following the current economic contraction in Brazil and its investment cycle is expected from VCSA.
Considerations that could lead to a positive rating action in the rating or Outlook):
A rating upgrade is unlikely in the near future for VCSA given the deteriorating conditions in the company's key market, investments in growth capex, and weaker credit metrics. A revision of the Outlook to Stable could occur if VCSA is successful in limiting its free cash flow burn and takes additional extraordinary measures to reduce its level of gross debt.
VCSA's liquidity is very strong. The company's cash position was BRL3.7 billion at June 30, 2016, which compared favorably to its short-term debt of BRL1.6 billion. VCSA's amortization schedule is manageable, with an average debt maturity of nine years. Current cash on hand can repay debt maturities through 2019, as the company does not have significant debt concentration in the short - and medium-term. VCSA also has access to a USD700 million revolving credit facility that expires in 2020. Furthermore, VCSA has strong capital market access in both Brazil and abroad. The company has been proactive in managing its financial profile by maintaining a high cash balance in domestic and foreign currencies.
FULL LIST OF RATING ACTIONS
Fitch has assigned the following ratings:
St. Marys Cement Inc.
--2026 senior unsecured notes of 'BBB-(EXP)'.
Votorantim Cimentos S. A
--Long-Term Local Currency Issuer Default Rating of 'BBB-';
--National Scale Rating of 'AAA(bra)'.
Fitch currently rates VCSA as follows:
--Long-Term Foreign Currency Issuer Default Rating 'BBB-';
--2021, 2022, and 2041 senior unsecured long-term notes 'BBB-'.
The Rating Outlook for the IDRs is Negative.