OREANDA-NEWS. Fitch Ratings has affirmed French-based electrical distributor Rexel SA's (Rexel) Long-term Issuer Default Rating (IDR) at 'BB' and Short-term IDR at 'B'. The Outlook is Stable. Fitch has also affirmed Rexel's senior unsecured rating at 'BB' and its EUR500m commercial paper programme at 'B'.

Rexel's ratings continue to reflect the company's high leverage with adjusted funds from operations (FFO) net leverage of 5.2x at end-2015 (after factoring in EUR605m readily available cash), balanced by an overall strong business profile as a worldwide leading distributor of electrical products.

Fitch projects limited EBITDA and FFO improvement over the next three years. This is because management's initiatives to strengthen Rexel's profit generation capacity are counter-balanced by high uncertainty over the pace and timing of market recovery in the group's main regions of operations. However, the Stable Outlook on the IDR reflects Fitch's expectation that the group will maintain strong financial flexibility, supported by healthy profit conversion into cash flow and a conservative financial policy, which are critical to deleveraging to levels consistent with the current ratings by 2017. The Outlook may be revised to Negative if Fitch expects adjusted FFO net leverage to remain above 5.0x for more than two years and profitability to be at or below the low level reached in 2015 on a sustained basis.

KEY RATING DRIVERS

Fragile Sales Growth Prospects
Fitch's rating case includes only limited organic sales growth from 2017 onwards, given uncertainty over market recovery in the group's main regions of operations and the late-cycle characteristics of its activities. Organic sales rebounded 1.1% in 2014 but declined 2.1% in 2015, mainly driven by weaker oil prices strongly affecting the North American industrial segment (46% of the region's sales in 2015), lower copper prices and the Chinese economic slowdown. Fitch's forecasts incorporate European market conditions strengthening from mid-2016 and the industrial North American and Chinese markets stabilising in 2017.

Profitability to Improve from 2017
The further decline in Rexel's EBITDA margin in 2015 (4.8% versus 5.6% in 2014) primarily stemmed from negative operating leverage related to lower sales volumes, lower copper prices and the completion of management's transformation plan in the US.

Fitch expects it to stabilise in 2016 and recover towards 5.6% in 2018. This remains weak compared with pre-2014 years, reflecting our cautiousness over the pace of market recovery. Nonetheless, management's initiatives to optimise the group's operating structure and gross margin should help stabilise EBITDA margin in 2016 and support positive operating leverage effect from organic sales recovery in future years. We also factor in positive impact from Rexel's divestment programme and management's focus on margin-accretive acquisitions.

Resilient Free Cash Flow
Despite limited uplift in EBITDA we expect Rexel to maintain a healthy level of free cash flow (FCF) in 2016-2018, at around EUR230m (1.8% of sales p.a.). Considering the group's high leverage and its acquisitive growth strategy, maintaining such a level is critical for the rating as a major component of financial flexibility.

FCF benefits from the business's low capital intensity and the countercyclical nature of its working capital needs. Critical additional support to FCF generation is management's strict financial discipline, which we expect to be maintained. Our rating case includes a further decrease in cash interests paid in 2016 due to past active debt management, as well as a limited increase in dividend distribution in the medium term following the strong reduction announced for 2016.

Limited Leverage Headroom
Rexel's adjusted FFO net leverage reached 5.2x in 2015 (2014: 5.0x), exceeding Fitch's guideline of 5.0x for a 'BB' rating. The elevated leverage results from high acquisition spending in 2012, followed by several years of challenging market conditions. Despite management's now more conservative approach regarding dividends, this leaves increasingly limited headroom for M&A under the current rating.

In its 2016-2018 rating case, Fitch has assumed a total EUR550m acquisition spending (previous assumption: EUR300m p.a. over 2015-2017) on companies generating profitability at or above group level, with annual acquisition spend increasing alongside profits. Under Fitch's assumptions, Rexel should be able to regain some rating headroom with adjusted FFO net leverage falling back below 5.0x in 2017.

Financial Flexibility
Rexel's financial flexibility, which we forecast to remain strong, mitigates limited deleveraging prospects over 2016-2019. It should be supported by the group's existing strong liquidity, intact FCF generation capacity, improving FFO fixed charge cover due to decreasing debt costs, and the maintenance of a strict financial policy.

In addition to the dividend decrease announced for 2016, we view positively management's ability at adapting its appetite for acquisitions to operating performance. This was demonstrated in limited spending over 2013-2015 and management's announcement of a reduced budget for average annual M&A spending in their 2016-2020 strategic plan, to EUR300m from EUR500m under former 2012-2015 plan. Fitch calculates that the lower dividends and M&A reduce the maximum potential total cash outflow by approximately EUR220m in 2016, consistent with weaker EBITDA growth prospects.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Rexel SA include:
- Sales decrease in 2016 driven by organic sales decline and further non-core assets divestures; slow recovery thereafter based on better market environment and bolt-on acquisitions
- Broadly stable EBITDA margin in 2016 before improving to 5.6% by 2018 supported by positive operating leverage along with sales growth and margin-accretive acquisitions
- Continued tight management of working capital needs
- Average annual FCF of EUR232m over 2016-2018
- Annual bolt-on acquisition spending growing along with improving operating performance, of EUR150m in 2016 and up to EUR300m in 2019 (total spending of EUR850m over 2016-2019)

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- EBITDA margin sustained at above 6%, reflecting higher resilience throughout the economic cycle
- FFO adjusted net leverage below 4.0x on a sustained basis
- Continued strong cash flow generation, measured as pre-dividend FCF margin comfortably above 2% (2015: 2.2%).

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- EBITDA margin consistently below 5%
-A large debt-funded acquisition, or a deeper-than-expected economic slowdown with no corresponding increase in FCF (notably due to working capital inflow and dividend restriction) resulting in (actual or expected) lease-adjusted FFO adjusted net leverage above 5.0x for more than two years.
-A contraction of pre-dividend FCF margin to below 2% as a result of weaker profitability and/or a less tightly managed working capital.
-A more aggressive shareholder-friendly stance leading to an erosion of FCF margin to below 1%.

LIQUIDITY
Liquidity was healthy as of 31 December 2015 with EUR805m of cash on balance sheet, of which Fitch considers EUR605m as readily available for debt service. It is further underpinned by EUR982m undrawn committed bank facilities. Rexel also has access to various receivable securitisation programmes and a EUR500m commercial paper programme.

Following the 2015 bond refinancing exercise Rexel has no major debt repayment before 2020.