OREANDA-NEWS. Fitch Ratings has revised NH Hotel Group S.A's. (NH) Outlook to Positive from Stable, while affirming its Long-term Issuer Default Rating (LT IDR) at 'B-'. Fitch has also affirmed NH's EUR250m 2019 senior secured notes at 'B+' with a Recovery Rating 'RR2.'

Fitch is also withdrawing the 'B+(EXP)' instrument rating on the planned issue of EUR200m 2022 secured notes, which the group has decided not to proceed with.
The change to Positive Outlook reflects our view that due to its refurbishment and brand repositioning programme, which is strengthening and diversifying its business model, NH should be able to maintain the improved operating performance it achieved in 2015.

The ratings are constrained by past under-investment in the hotel portfolio, which has been addressed with a significant capex programme to be substantially completed by end-2016. While we expect some deleveraging over the next three years, this may be limited by potential dividend payments from 2017 onwards.

The Outlook is likely to return to Stable if Fitch believes that its sensitivities for an upgrade are not achievable in the next two years.

Operating Performance Improving
EBITDA increased in 2015, with revenue per available room (RevPar) growing at 11% yoy. This positive trend should be maintained in 2016, as refurbishment leads to average room rate rises, although lower than in 2015.The trend also underlines the group's move to upmarket hotels with the conversion of around 21 hotels to the upscale NH Collection brand, achieving higher room rates (between 30% and 50% additional ARR versus an NH room) through increased bookings from new business users.

Growing Upscale Presence
The expansion and development plan includes the development of further NH Collection four star plus hotels, which should increase the portfolio to a total of close to 70 hotels and 11,000 rooms by end- 2017. Overall NH Collection hotels deliver an ARR of between 30% and 50% more than a normal NH hotel. This upscale hotel format underpins our estimate of EBITDA growth from 2016 to 2018.

Attractive Hotel Portfolio
The majority of NH hotel properties are in or around major European and Latin American cities. As a result, the portfolio's valuation (EUR1.6bn at end-2014) has proven resilient and become a primary source of liquidity in recent years. The properties further serve as collateral for the group's secured debt. In additional NH has identified up to EUR140m of hotels that could be disposed of in 2016.

Evolving Lease Liabilities
During 2015 the group terminated leases and renegotiated lease contracts, resulting in an annual gross savings of around EUR7m p.a. (before new leases signed). This process should continue in 2016, ensuring leases remain stable as a percentage of revenues at around 20%. They are, however, still high compared with peers (Accor: 15% in 2015).

High but Slowly Improving Leverage
Leverage is in the 'B' category and we expect some moderate deleveraging in 2016, which constrains the ratings. Based on our conservative EBITDA growth assumptions, we project that FFO lease-adjusted net leverage should improve but remain above 7.0x at end-2016 (7.7x at end 2015). This compares unfavourably with peers, Accor and Whitbread, and reflects projected high capex in 2016 that will absorb potential FCF generation in that year. While we expect some deleveraging over the next three years, this may be limited by potential dividend payments from 2017 onwards.

Nevertheless, the Positive Outlook is based on the scope for better-than-expected performance, due to improved momentum in NH's core markets of Italy and Spain.

Gradual Shift to Online
At end-2015 around 50% of bookings were through direct channel (ie own website and mobile apps) against third-party website bookings. NH is targeting for 55% of all bookings to be made directly by 2018, which is still moderate by European standards, although acceptable by southern Europe standards.

Strong Expected Recoveries
The 'RR2' on the senior secured notes reflects Fitch's expectations that the valuation of NH - and resulting recoveries for its creditors - will be maximised in a liquidation due to the significant value of the group's owned real-estate portfolio, which also benefits from unencumbered assets with an estimated value of around EUR600m at end-October 2015. We assume a fairly conservative 7x multiple in a distressed scenario.

Successful Asset Disposals
NH sold the Sotogrande estate for EUR178m in 2014 and achieved a further EUR33m of disposals in 2015, which has improved financial flexibility, allowed some debt repayment and funded capex. NH plans to sells a further EUR140m of hotel assets in 2016, reflecting its continued push to dispose of under-performing or non-core assets.

Asset-Light Slowly Increasing
The asset sales in 2014 and 2015 demonstrate NH's move to increase the portion of the overall portfolio under a "managed" format as opposed to the "owned" structure currently in place. Since 2008, NH has increased the properties under management to 24% at end-2015. This changing business model combines the benefits of lower capex needs with reduced volatility of profits. Nevertheless the group remains an asset heavy/leased business model, rather than the US-asset light hotel business profile.

Acceptable but Thin Liquidity
NH's unrestricted cash was EUR42m at end-2015, down from EUR165m at end-2014, as a result of the higher capex and the acquisition of the Colombian hotel group, Hoteles Royal, during 2015. Capex to reposition the hotels, expand and develop new projects and upgrade the IT network for the coming three years will remain high in 2016 and is likely to drain operating cash, leading to net cash outflows. With the repositioning likely to be completed by end-2016, we estimate capex will return to more normal levels of between 4% and 6% of revenues.

Debt maturity slightly improved in FY15, with the extension of the maturity of the EUR171.5m syndicated loan facility by a year to October 2018. 2018 will be a key refinancing year with EUR439m to be repaid, including the EUR250m convertible bonds.

Fitch's key assumptions within our rating case for the issuer include:
- Occupancy and ARR growth will be lower than management's expectations, particularly from 2017 onwards. Nevertheless, we assume RevPar to increase as the repositioning plan completes, a greater number of NH Collection upscale rooms become available, and improved room yield management takes effect. But 2016 overall RevPar increase will be more moderate than in 2015.
- Operating lease costs of between around EUR300m p.a. and EUR335m p.a. from 2016 to 2018.
- Capex (maintenance and repositioning/development) between EUR160m and EUR170m reflecting that around 80% of repositioning spending will be completed by end-2016.
- Potential dividend payments from 2017 onwards.
- Deferred payment for Hoteles Royal of EUR17.7m in 2017.

Positive: Future developments that may, individually or collectively, lead to positive rating actions include:
- Sustained improved trading performance leading to group EBITDA margin (excluding one-off gains) being sustained at or above 10% (FY15: 9.1%)
- Leverage reducing sustainably to FFO lease-adjusted net leverage below 7.0x.
- EBITDAR/(gross interest +rent) sustainably above 1.5x or FFO fixed charge cover above 1.3x (FY15: 1.2x)
- Demonstrated sustained positive free cash flow (FCF).

Negative: The Outlook is likely to return to Stable if Fitch projects that the above sensitivities for an upgrade are not achievable over a two-year horizon.

Future developments that may, individually or collectively, lead to a downgrade include:
- Weakening occupancy or pricing leading to group EBITDA margin (excluding one-off gains) falling below 6%
- Weaker operational cash flows leading to higher continued FCF outflows, resulting in strained liquidity
- FFO lease adjusted net leverage above 9.0x
- EBITDAR/(gross interest + rent) below 1.1x or FFO fixed charge cover below 1.1x on a sustained basis.

- Leases: Fitch has adjusted the debt by adding 8x of yearly operating lease expense to long-term assets of EUR283m in 2015
- Cash: We have adjusted available cash at end-December 2015 by deducting EUR35m for restrictions, working capital and operational requirements.