OREANDA-NEWS. Fitch Ratings has downgraded the ratings of Arcos Dorados B.V. (AD) and Arcos Dorados Holdings Inc. (Arcos), as well as the BRL675 million and USD475 million senior unsecured notes issued by Arcos, to 'BB+'. The Outlook for the corporate ratings is Negative. A full list of rating actions follows at the end of this press release.

KEY RATING DRIVERS

The downgrade of Arcos' and AD's ratings reflects the company's weak operating performance, which has felt the impact of a very challenging macroeconomic environment in Latin America, specifically in Venezuela, Brazil, and Mexico. Soft consumption across the region and currency devaluations have contributed to an increase in the company's net lease-adjusted leverage above 4.5x, which is above the 3.5x ratio expected by Fitch. The Negative Outlook reflects concern that the company may not be able to reduce its net lease-adjusted debt-to-EBITDAR ratio to below 4.0x within the next 12 to 24 months.

Weak Regional Performance

Increased volatility in Venezuela, a soft consumer environment in Brazil and Mexico, and currency devaluations have contributed to a sharp decline in EBITDA. Arcos' Fitch-calculated EBITDA was USD233 million during the LTM ended March 31, 2015. This figure compares with USD240 million at year-end 2014 and USD343 million at year-end 2013. Fitch forecasts regional GDP growth to be 0.5% in 2015 and a contraction of 1% in Brazil, which is Arcos' largest market.

Increased Importance of Brazil

Brazil is the company's largest market, contributing to 50% of sales and 76% of EBITDA during 2014. Excluding operations in Venezuela and Argentina, Fitch estimates these figures to be about 60% and 85%, respectively. Brazil has become increasingly important to the success of Arcos' operations in Latin America and is the main market for its three-year restaurant opening plan under the master franchise agreement (MFA) with McDonald's Corporation ('BBB+', Outlook Stable). Negatively, Brazilian consumption has stagnated and Fitch expects soft consumption for the next 12-18 months.

Increased Leverage

Arcos' net lease-adjusted leverage was 4.6x as of Dec. 31, 2014; this compares negatively to an average of 3.2x maintained from 2010 to 2013. Fitch estimates that its net lease-adjusted debt/EBITDAR excluding EBITDA from Venezuela and Argentina is about 4.9x. Arcos' decision to suspend dividend payments in 2015 and slow the pace of its expansion under the MFA is positive and should reduce pressure on the company's cash flow generation. In 2015 the company expects to have 40-45 gross restaurant openings. In the absence of real estate asset sales and/or the realization of other measures announced by the company, such as re-franchising, Fitch does not expect a significant deleveraging in the next couple of years. The company seeks to sell around USD200 million of assets, which would lower leverage to around 3.5x.

Exposure to Transferability Risk

Arcos is exposed to high transferability risk in its Venezuelan operations. Restrictions imposed by the Venezuelan Central Bank have limited the U.S.-dollar supply in that country, which constrains the repatriation of available cash and restricts payment for imported goods as well as royalties. Following measures announced by the local government, Arcos obtained a temporary waiver to reduce royalty payments to McDonald's Corporation in 2012, 2013, and 2014. Fitch estimates that Venezuela represented about 5% of total sales in 2014. Arcos is also exposed to transferability risk with its Argentine operation. However, this risk is partially mitigated by the fact that its local operation does not generate excess cash, as Arcos' headquarters is based in Argentina.

MFA with McDonald's

The MFA sets strict strategic, commercial, and financial guidelines for Arcos' operations which support the operating and financial stability of the business as well as the underlying value of the McDonald's brand in the region. Arcos is the largest McDonald's franchisee in the world in terms of system-wide sales and number of restaurants. About 75% of the restaurants are operated by Arcos, and the remaining 25% are franchised restaurants. The company's 2015 strategy includes 40-45 restaurants (gross openings) that would require investments of USD90 million to USD120 million. In 2014 Arcos was not in compliance with certain debt covenants established by the MFA; McDonald's granted a waiver through March 31, 2015. In addition, the company is in negotiations with McDonald's to modify the current three-year expansion plan given the weak Latin American environment.

Under the terms of the MFA, McDonald's has a call option to repurchase its assets in the region under certain events. Terms of the notes specify that these funds should be applied to debt repayment. The call option price is set as the fair market value of all assets of the operating companies (80% in the case of a material breach), minus debt at operating company and contingencies, plus cash. The MFA requires all group companies to remain current on their financial obligations to avoid a material breach of the agreement.

Strength of McDonald's Franchise

The ratings also incorporate the strength of McDonald's as franchisor and its long-standing relationship with Arcos' owners and management. Arcos' controlling shareholder was the joint venture partner of McDonald's in Argentina for over 20 years and served as president of the McDonald's South America division from 2004 until the acquisition. On average, the management team has worked for over 12 years at McDonald's.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for Arcos include the following:

--No growth in sales or EBITDA in 2015 due to weak regional environment, specifically Brazil
--Revenues grow 1% in 2016, 1.5% in 2017 and 2% in 2018
--30% devaluation in Argentina in 2016
--EBITDA margin approaches 8% by 2018
--No dividends in 2015 or 2016
--BRL bond refinanced in 2016
--Arcos receives about USD200 million from 2016-2018 in real estate asset sales and redevelopment. Proceeds used to reduce debt.
--Modest annual deleveraging to reach a net lease-adjusted leverage ratio of around 3.5x by 2018

RATING SENSITIVITIES

Arcos' ratings could be negatively affected by continued weak performance in Brazil; significant deterioration of same store sales; and higher than expected investments and dividends, pressuring free cash flow FCF and leverage ratios. Additional factors that could lead to consideration of a further downgrade include: inability of Argentine and Venezuelan operations to be self-sustaining; failure to comply with the terms of the MFA; failure to execute non-core real estate asset sales; and/or a consolidated net lease adjusted debt-to-EBITDAR ratio above 4.0x on a sustained basis.

A positive rating action is not likely in the near- to medium-term. The ratings could be positively affected by higher than expected cash generation from investment-grade countries that would lead to a material improvement in leverage metrics such as net lease-adjusted debt levels below 3.5x.

LIQUIDITY

Arcos had USD2 billion of total adjusted debt and USD71 million of cash and marketable securities as of March 31, 2015; the company has about USD4 million of cash in Venezuela which Fitch considers as restricted cash. Short-term debt totaled USD64 million, which includes about USD10 million in derivatives, USD5 million in interest, and a USD5 million current portion of long-term debt. Liquidity is further enhanced by a USD75 million revolving credit facility with Bank of America which matures in August 2015. As of March 31, 2015, Arcos had borrowed USD35 million due in April 2015. Fitch expects that this facility will be renewed for an additional two years. In addition, Arcos has credit and debit card receivables of about USD39 million as of Dec. 31, 2014, meal voucher receivables of USD13 million, and USD38 million in receivables from franchisees.

FULL LIST OF RATING ACTIONS

Fitch has downgraded the following ratings:

AD
--Foreign currency Issuer Default Rating (IDR) to 'BB+' from 'BBB-';
--Local currency IDR to 'BB+' from 'BBB-'.

Arcos
--Foreign currency IDR to 'BB+' from 'BBB-';
--BRL675 million senior unsecured Brazilian-real notes due 2016 to 'BB+' from 'BBB-';
--USD473.767 million senior unsecured notes due 2023 to 'BB+' from 'BBB-'.

The Outlook for the corporate ratings was revised to Negative from Stable.