OREANDA-NEWS. Fitch Ratings has affirmed Carlsberg Breweries A/S's (Carlsberg) Long-Term Issuer Default Rating (IDR) and senior unsecured ratings at 'BBB' and Short-Term IDR at 'F3'. The Outlook on the Long-Term IDR is Stable.

The affirmation reflects Fitch's view that Carlsberg's credit metrics are returning to levels more commensurate with the ratings, after successful cash preservation measures in 2015. Fitch assumes ongoing challenges in eastern Europe and China to be offset by other more profitable markets in Asia and a stable western European business in 2016. We expect cash generation to be solid owing to the company's commitment to, and ability to achieve, deleveraging as demonstrated in 2015. Fitch does not assume any material M&A activity in 2016.

KEY RATING DRIVERS
Solid Cash Generation Capabilities
Carlsberg has been successful in its cash preservation measures, which included reducing capital expenditure, assigning a low priority to M&A, and intensifying its cost-rationalisation programme globally with the closure of two of its Russian breweries. These initiatives, along with a material improvement in working capital, helped free cash flow (FCF) to recover to DKK4.6bn (2014: negative DKK0.1bn).

In announcing its new strategy SAIL '22 in March 2016, Carlsberg confirmed that it will remain focused on strengthening its financial profile over the medium-term with no expected material growth in capex or M&A spending. Fitch forecasts FCF of DKK2bn-DKK3.5bn p.a. over 2016-19, which corresponds to a healthy annual FCF margin of 3.3%-4.7%, a level commensurate with the 'BBB' rating.

Ongoing Challenges Expected in 2016
We expect 2016 organic revenue growth to remain modest (2015: 2% yoy). We expect sales in eastern Europe and China to decline, with the latter weighing on growth of the Asian business in the near-term. However, continued strong performance in other more profitable key markets in Asia will likely limit this negative impact. We also expect limited growth prospects in western Europe, due to keen competition and portfolio optimisation (exiting from unprofitable sales contracts as seen in Finland and Poland recently). However, the company's continued innovation efforts, including in craft beers, should enable Carlsberg to defend its revenue in these mature markets.

Fitch expects no material profit margin improvement in 2016, as most of the gains from the company's efficiency programmes are likely to be reinvested into Carlsberg's brands. We have also assumed negative FX transactional impact from emerging markets. Fitch expects cash benefits from the financial efficiency initiatives to start feeding through from 2017 onwards.

Deleveraging on Track
As a result of the cash flow preservation measures, Carlsberg reduced its funds from operations (FFO)-adjusted net leverage to 3.6x in 2015 from a peak of 4.2x in 2014. We expect deleveraging will continue over 2016-17 with FFO-adjusted net leverage declining to around 3x by 2017, progressively creating headroom against our negative rating trigger of 3.5x leverage. As part of its new strategy SAIL'22, Carlsberg confirmed its commitment to further reduce leverage to a net interest bearing debt-to-EBITDA target of below 2x, which we estimate will be achievable by 2018.

Declining Importance of Russia
Fitch believes the increasing importance of Carlsberg's Asian markets (2015: 32% of group EBITDA before central costs) and the relatively stable western Europe - the largest contributor of group profits (2015: 53%) - will continue to reduce Carlsberg's reliance on the challenging Russian market over the medium- to long-term. The EBITDA contribution from eastern Europe to the group declined to 17% in 2015 from almost 30% (before central costs) in 2012.

Competitive Risks
We believe that the upcoming merger of the two global industry leaders, Anheuser Busch InBev NV/SA (ABI; BBB+/RWN) and SABMiller plc (SABM; A-/RWN), is unlikely to materially impact the competitive landscape for Carlsberg in its core European market, at least in the short- to medium-term.

We expect the enlarged ABI/SABM post-merger to focus on its integration and on paying down debt. Also we believe ABI is likely to view Europe as less strategic given limited upside to beer volume sales. The agreed divestment of SABM's European beer brands Peroni, Grolsch and Meantime to Japanese Asahi Group Holdings and the recent announcement of the potential disposal of SABM's central and eastern European business further supports this view. Unless these SABM assets are sold to major competitor Heineken, there will be no additional meaningful competitive pressures for Carlsberg in Europe in the short-term.

M&A Risks
ABI has offered to sell SABM's central and eastern European assets. These assets are estimated by market commentators to generate around USD460m in EBITDA and worth around USD6bn. While we believe that the assets for sale might be of interest to Carlsberg given its limited presence in this part of Europe, a major acquisition would be a departure from the company's current strategy of fixing its existing business and deleveraging its balance sheet. Therefore, while no major acquisition is factored in the ratings, we estimate that a debt-funded acquisition of this magnitude could lead to a downgrade of Carlsberg's IDR by up to two notches.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for the issuer include:
- Devaluation of RUB/USD rate by 15% on average in 2016 to 72 RUB/USD.
- Flat revenues in 2016, followed by low- to mid-single digit annual growth, supported mostly by price-mix effect and further expansion in Asia.
- Modest EBITDA margin declines in 2016, followed by stable EBITDA margins at around 21%
- Capex at around DKK4bn-DKK4.5bn over 2016-19.
- No dividend increases over 2016-17; 3%-4% annual increases thereafter.
- No material M&As.

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Continuation of a strong competitive profile leading to group EBITDAR margin above 25% (2015: 20%), FCF margin above 5% (2015: 6.6%) or annual FCF of DKK4bn (2015: DKK4.3bn).
- FFO-adjusted net leverage falling below 2.5x.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- A severe decline in operating performance from key markets (e.g. Russia) causing FFO- adjusted net leverage to remain above 3.5x.
- An erosion of FCF to below DKK2bn or FCF margin below 3.5%.
- A shift in financial policy towards a much stronger remuneration of shareholders, coupled with an increased M&A appetite.
- Material deterioration of economic and geopolitical conditions in key markets causing a severe negative impact on Carlsberg's operations.

LIQUIDITY
Carlsberg had DKK1.6bn in unrestricted cash at end-2015 and we project FCF generation of around DKK2bn in 2016. Liquidity is also supported by undrawn committed facilities amounting to DKK16.8bn at end-2015. Given the long-term nature of Carlsberg's debt profile we estimate liquidity is strong, with annual FCF and existing facilities covering most debt repayments.