OREANDA-NEWS. Fitch Ratings has upgraded French food group Elior SA's (Elior) Long-term Issuer Default Rating (IDR) to 'BB' from 'BB-'. The Outlook is Stable.

The ratings for Elior's senior secured credit facilities and Elior Finance & Co. SCA's EUR350m senior secured notes are also upgraded to 'BB+' from 'BB'. Fitch expects superior recovery prospects for senior creditors in case of default, which under its 'Recovery Ratings and Notching Criteria for Non-Financial Corporates Issuers' methodology results in the senior secured rating being one notch higher from the IDR.

The upgrade takes into account a continuing stable and resilient business model enabling a step up of free cash flow generation, Elior's strong brand name, broad range of services, and diverse customer base, as well as Fitch's expectations that Elior will meet the agency's positive sensitivity guidance over the two-year rating horizon to September 2018. The ratings are supported by the company's long-term contracts, its large scale, high retention rates and barriers to entry as well as steady margin and cash flow generation.

KEY RATING DRIVERS
Stable Resilient Business Model
Elior's large scale, strong brand name, broad range of services, a diverse customer base and high barriers to entry support steady profitability and cash flow. The ratings continue to be underpinned by a stable and resilient business model, supported by long term growth prospects and the ongoing trend towards outsourcing. Revenues are stable with low contract renewal risk, supported by medium- to long-term contracts in its concession catering and high retention rates of over 90% in its contract catering business.

Factors Constraining Investment Grade
Elior has many key sector specific factors that are commensurate with a low investment-grade rating, but the rating is constrained by a lack of geographical diversification and by high leverage. The group has concentration in France and the southern European countries accounting for around 80% of group revenues for the financial year to September 2015. This, together with high leverage, constrains the rating from being upgraded to the investment grade category compared with peers Compass Group (A-/Stable) and Sodexo S.A. (BBB+/Stable).

Focus on International Expansion
To reduce its concentration in the weakened eurozone, Elior has announced a EUR1bn five- year acquisition programme aimed at expanding its presence in the US and the UK . We view the expansion strategy as positive for the ratings as it will enable higher diversification of revenues, greater scale and synergies. Elior's diversification into the US and UK will mitigate geographical concentration in France and other southern European countries. Execution and FX exposure will heighten, but Fitch is confident in management's track record so far and its ability to manage these risks.

Steady Margin Progression
Fitch expects Elior's EBITDA margin to be stable and steadily increase towards 9% by FY18, from 8.3% in FY15, which is at the high end compared with its immediate peers. In its contract catering division, which accounted for 64% of EBITDA at end-FY15, we expect margins to improve slightly as economies of scale offset cost inflation. In the higher-margin concession catering division, we expect profitability to remain fairly stable, with any improvements from scale being offset by the competitive nature of contract acquisition. We understand that in most of its contracts the company benefits from the ability to pass on the majority of its costs through pricing adjustment mechanisms.

Improving FCF Generation
We project free cash flow (FCF, after payment of dividends) of at least EUR100m pa, which will allow self-funding of part of the targeted M&A effort. As a percentage of revenue, FCF should be around 2% over the next two years, which is line with the median for a 'BB' rating and meets our positive sensitivity guideline. The asset-light nature and low capital-intensity of the business allows Elior to consistently convert operating profits into positive cash flow.

Steadily Improving Credit Metrics
We expect funds from operations (FFO) gross leverage to steadily reduce to around 4.3x by FY18, which is within our positive sensitivity guideline. The announced acquisition spend of EUR1bn over the period 2016-2020 will slow deleveraging in the near term, but this is balanced by the group's growth strategy into new geographies improving its scale and diversification.

FFO fixed charge coverage is steadily improving (2.8x in FY15 vs. 2.0x in FY14), which we expect will be at the upper end of the 'BB' rating category within the next two years.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Steady, low single digit organic sales growth, slightly offset by lost contracts. Acquisitions driving further sales growth, with much of the activity expected in the early years of the 2016-2020 plan.
- EBITDA margin trending towards 9% by FY18, driven by a combination of slower decline of gross margin and improved bargaining power with suppliers, as well as operational efficiencies, both largely a result of improved size and scale.
- FCF generation in the region of 1.5%-2.5% over the next two years. This will be slightly lower in the early years as a result of planned restructuring costs of EUR30m in FY16 and FY17.
- Total acquisition spending of roughly EUR1bn between FY16 and FY20. We expect that approximately half of this will be completed in FY16 and FY17.

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
-Additional business diversification, by segment and/or geography, leading to improved revenues and operating profits

-Further deleveraging resulting in FFO adjusted gross leverage below 4.0x on a sustained basis (FY15: 5.7x)

-FFO fixed charge coverage above 3.5x (FY15: 2.8x) on a sustained basis

-FCF (post dividends) of at least 2% of sales on a sustained basis (FY15: 1.2%)

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

-Evidence that underlying and acquired businesses are performing below expectations and/or increases in cost base leading to weakness in revenue growth and EBIT or FFO margin down to around 5% (FY15: 5.6%).

-FFO adjusted gross leverage not reducing below 5.0x on a sustained basis

-FFO fixed charge coverage below 3.0x on a sustained basis

LIQUIDITY
Adequate liquidity
Elior had unrestricted cash (as defined by Fitch) of EUR175m at FYE15, together with access to around EUR520m of undrawn revolving credit facilities. This is sufficient to address business needs and moderate debt repayments for 2016 and 2017 of around EUR125m.

Improving Leverage
The debt maturity is well spread with a lower average interest cost of 3%, following Elior's IPO and refinance of bank facilities at more favourable rates. Refinance risk is low with the next significant maturity being the receivables facility in June 2018 totalling EUR300m, which we have included in our calculations for coverage purposes.

Summary of Financial Statement Adjustments
Fitch has adjusted the debt by adding 8x of yearly operating lease expenses related to long term assets of EUR72m.

Fitch has deducted EUR30m of cash as 'Not readily available' Cash & equivalents to reflect working capital fluctuations.