OREANDA-NEWS. Fitch Ratings has downgraded LATAM Airlines Group S.A.'s (LATAM) long-term foreign currency Issuer Default Rating (IDR) to 'B+' from 'BB-'. In addition, Fitch has downgraded TAM S.A.'s (TAM) foreign and local currency IDRs to 'B+' from 'BB-' and its national long-term rating to 'A-(bra)' from 'A (bra)'. Fitch has also downgraded LATAM and TAM's unsecured notes to 'B+/RR4' from 'BB-'. The Rating Outlook for the corporate ratings has been revised to Negative from Stable. A full list of rating actions follows at the end of this release.

The ratings downgrade and Negative Outlook reflect LATAM's weaker-than-expected consolidated operational performance during 2015, and Fitch's view that the company's key credit metrics, mainly operating margins, leverage, and FCF generation, will remain pressured over the next 12 to 18 months. Fitch believes that prevailing unfavorable economic conditions in Latin America will make it more difficult for the company to execute deleveraging during 2016-2017. The Negative Outlook also considers LATAM's higher leverage and weaker operational performance versus its global peers within the rating category.

LATAM's ratings incorporate its diversified business model, important regional market position, and adequate liquidity, which are tempered by its high gross adjusted leverage and ongoing weak operational performance. Despite the company's solid business position in the domestic and international Brazilian market, the company has failed to mitigate volatility in its operational results within these markets through the economic cycle. Brazil's subdued macroeconomic conditions will continue to challenge the company's operational performance during 2016.

The ratings of LATAM and TAM and their subsidiaries take into account the credit linkage between the two companies, which stems from their legal, operational, and strategic ties. These links are reflected in the existence of cross-guarantee and cross-default clauses related to the financing of aircraft acquisitions for both LATAM and TAM.

KEY RATING DRIVERS

Operational Performance below Expectations:

LATAM's 2015 net revenues reached USD10.1 billion, representing a decline of 18.8% when compared with 2014 net revenues. This considers a 19% and 22.4% decrease in passenger and cargo revenues, respectively. The company's 2015 top line was primarily driven by a sharp 21% decline in passenger yields, while transported passenger remained relative stable. The company's 2015 total costs declined by 20%, which included a 36.4% reduction in fuel cost during the period. The company's 2015 operational performance was below expectations incorporated in the ratings. LATAM's 2015 EBIT margin was 5.1% after reaching 4.9% and 4.1% during 2013 and 2014, respectively.

Fitch anticipates the company's 2016 net revenues declining by the single digits as a result of continued decline in yields. Although yields should remain under pressure during 2016, Fitch expects the company's 2016 operational performance to reach some improvement, as the company expects to benefit from several initiatives aimed at reducing ex-fuel cost as well as lower fuel cost - with a more favorable hedge position in terms of fuel cost management in 2016 against 2015.

High Adjusted Leverage of 6.4x:

LATAM's adjusted gross leverage metric is high and remains weak for the rating category. The company's increase in its adjusted gross leverage during 2015 primarily reflects its limited capacity to improve the operational performance during last year. Although Fitch's rating case is assuming the company will improve its operational performance during 2016, this is not expected to result in a material reduction in the company's adjusted gross leverage, with levels still above 6x.

LATAM's adjusted gross leverage, measured as total adjusted debt/EBITDAR, was 6.4x at Dec. 31, 2015, compared with 6.1x in 2014. The company's total adjusted debt was $12.9 billion at Dec. 31, 2015. This debt includes $9 billion in on-balance-sheet debt and $3.7 billion in off-balance-sheet obligations related to operating leases with combined rental payments of around $525 million in 2015. The company's total on-balance-sheet debt is 79% secured debt, while the remaining (21%) is unsecured as of Dec. 31, 2015.

Moderate Consolidated Capacity Increase:

The company's consolidated capacity is expected to grow around 1% - 2% in 2016 after increasing 2.8% in 2015. LATAM's main efforts to reduce capacity during 2016 will be in the Brazilian domestic market and international markets. By segment, LATAM's capacity management in 2015 was +6.4% (-2%, 2014) in the international segment, -2.5% (-1%, 2014) in Brazil's domestic segment, +4.8% (+4%, 2014) in the Spanish-speaking domestic segment, and -1.9% (-6%, 2014) in the cargo segment. LATAM plans capacity increases/decreases) in 2016 of between +3% and +5% in the international segment, -8% to -10% in Brazil's domestic segment, between +6% and +8% in the Spanish-speaking domestic segment, while the cargo segment should see a contraction in the range of 0% to -2%.

Fitch expects the company's exposure to the Brazilian market will continue to challenge its operational performance, as the Brazilian airline industry is facing a business environment characterized by declining demand, low corporate travel activity, and weak economic growth expectations coupled with a declining yield atmosphere. Operations in Brazil represented approximately 34% of the company's total revenues during 2015. The company is expected to counterbalance the negative impact of these factors by focusing on capacity management, cost control, and consolidating its network strategy around its position in Guarulhos, Brasilia, and Congonhas airports

Adequate Liquidity:

Fitch views the company's liquidity position as adequate for the rating category. At Dec. 31, 2015, the company had cash of USD1.2 billion, along with USD105 million in unused committed credit lines. This level of liquidity, measured as total cash and marketable securities plus unused committed credit lines over LTM revenues, represents 13.1% of the company's revenues for LTM Dec. 31, 2015. This ratio is expected to be around 17% to 13% during 2016. The company plans to close by the end of March 2016 a 3-year senior secured revolving credit facility (RCF) of approximately USD300 million. The RCF will be collateralized by a combination of aircraft, spare engines and spare parts. In addition, LATAM faces debt amortizations of USD1.1 billion and USD1.1 billion during 2016 and 2017, respectively, which will be primarily addressed through refinancing. Furthermore, the company's coverage ratio, measured as EBITDAR/(Net Interest Exp. + Rents), was 2.3x in 2015 and it is expected to remain at this level during 2016-2018.

2016-2018 Fleet Commitments and Revised Fleet Capex Incorporated:

During March 2016, LATAM reached a USD2.9 billion reduction in fleet commitments for 2016 - 2018; this is in line with the company's previously announced plans to achieve a 40% reduction in its fleet commitments for the period. In addition to this plan, the company sold four Airbus A330s, redelivered three Airbus A330s, one Boeing 767, and four Airbus A320s and subleased one Boeing 777 Freighter to a third party during 2015, and continues to seek opportunities to adjust fleet commitments beyond the USD3 billion announcement. LATAM maintains a capex plan - including fleet and non-fleet capex - that calls for capex levels of USD1.2 billion and USD1 billion during 2016 and 2017, respectively.

During 2015, the company's free cash flow (FCF) generation was negative USD246 million, resulting in FCF margin (LTM FCF/LTM revenues) of negative 2.4%. The 2015 FCF calculation reflects USD1.3 billion, USD1.6 billion, and USD35 million in cash flow from operations, net capex; and paid dividends, respectively. The company's 2015 negative FCF trend results primarily from its net capex, which represented approximately 16% of total revenues during the period. Fitch expects the company to manage its capital intensity, measured as the capex/revenue ratio, at around 13%, 10%, and, 11% during 2016, 2017, and 2018 respectively. Fitch is projecting the company's FCF margin to be basically neutral during 2016-2018.

Strong Credit Linkage:

LATAM indirectly maintains substantially all of the economic rights and 20% of the voting rights in TAM, which is an affiliate company of LATAM. The ratings of LATAM and TAM also incorporate the strong credit linkage between both entities with significant legal, operational and strategic ties existing between the two companies. In addition, financing of the combined fleet plan capex is primarily implemented through LATAM, with the new aircraft being subleased to TAM. Furthermore, the view of strong legal ties existing between LATAM and TAM is supported by cross default clauses incorporated in LATAM's USD500 million unsecured notes due in 2020.

KEY ASSUMPTIONS

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

--2016 total transported passengers to increase around 3.4%
--2016 consolidated yield to decline by high single digits
--2016 net revenues to decline around 8%
--2016 EBIT margin approximately 6.5%
--2016 gross adjusted leverage, measured as total adjusted debt to EBITDAR, around 6.3x
--2016 Coverage ratio, EBITDAR/(Net Interest Expense + Rents), around 2.33x
--2016 Liquidity, measured as readily available cash plus unused committed credit facilities over LTM net revenues, around 13%
--2016 Net Capex levels around USD1.2 billion
--2016 FCF generation neutral to slightly negative at around USD200 million.

RATING SENSITIVITIES

Considerations that could lead to a negative rating action (Rating or Outlook):
--Sustained negative free cash flow;
--Liquidity, cash/LTM revenues, consistently below 10%
--Gross adjusted leverage consistently above 5.5x;
--EBIT margin consistently below 7%;
--Coverage ratio, measured as total EBITDAR/(Interest Expenses + Rents), consistently below 2.25x

Considerations that could lead to a positive rating action (Rating or Outlook):
Fitch may take a positive rating action if a combination of the following factors takes place:
--Liquidity, cash/LTM revenues, consistently above 15%
--Gross adjusted leverage consistently approaching 4.5x;
--Neutral to positive FCF generation;
--Coverage ratio, measured as the total EBITDAR/(Interest Expenses + Rents), consistently above 2.5x
--EBIT margin moving to 8%.

FULL LIST OF RATING ACTIONS

Fitch has taken the following rating actions:

LATAM Airlines Group S.A.:
--Long-term Issuer Default Rating (IDR) downgraded to 'B+' from 'BB-';
--National Equity Rating downgraded to 'Primera Clase Nivel 3 (cl)' from 'Primera Clase Nivel 2 (cl)'.
--USD500 million senior unsecured note due 2020 downgraded to 'B+/RR4' from 'BB-'.

TAM S.A.
--Long-term IDR downgraded to 'B+' from 'BB-';
--Local currency IDR downgraded to 'B+' from 'BB-';
--National long-term rating downgraded to 'A-(bra)' from 'A(bra)'.

Tam Linhas Aereas S.A.
--Long-term IDR downgraded to 'B+' from 'BB-';
--Local currency IDR downgraded to 'B+' from 'BB-';
--National long-term rating downgraded to 'A-(bra)' from 'A(bra)'.

Tam Capital Inc.
--USD300 million senior unsecured note due 2017 downgraded to 'B+/RR4' from 'BB-'.

Tam Capital Inc. 3
--USD500 million senior unsecured note due 2021 downgraded to 'B+/RR4' from 'BB-'.

The Rating Outlook for the corporate ratings has been revised to Negative from Stable.