OREANDA-NEWS. Fitch Ratings has upgraded NH Hotel Group SA's (NH) Long-Term Issuer Default Rating to 'B' from 'B-' and the group's 2019 senior secured notes to 'BB-'/'RR2' from 'B+'/'RR2'. Fitch has also assigned a 'BB-'/RR2' rating to the group's new EUR285m 2023 senior secured notes. The Outlook is Stable.

The upgrade reflects both the improved liquidity of NH, due to the signing of a new EUR250m three-year plus two revolving credit facility (RCF), and better structural and cyclical operating performance so far in 2016. The substantial increase in committed undrawn RCF facilities to EUR250m is a significant credit positive in terms of liquidity for a hotel group, which remains asset-heavy by way of hotel ownership.

The reinforcement of the group's liquidity profile is accompanied by continued strong operational performance so far in 2016 in the group's main market Spain and, to a lesser extent, Italy and central Europe, due to strong demand. NH's structural performance has also been enhanced by the heavy capex programme launched between 2014 and 2016 to upgrade and segment the hotel portfolio to reflect customers' higher requirements, changing demographics and differing tastes.

Following issuance of the new EUR285m senior secured notes, NH also displays a more solid capital structure, with an extended and smoother debt maturity profile.

KEY RATING DRIVERS

Enhanced Liquidity Profile

The new EUR250m RCF (which we expect should remain largely undrawn), together with the EUR285m 2023 senior secured notes, will significantly enhance the group's liquidity profile, by repaying the outstanding syndicated credit, club loans and small outstanding individual mortgages. We view this enhanced liquidity as a particularly important source of financial flexibility for an asset-heavy hotel group that, due to its still high fixed cost base, remains exposed to performance volatility in a downturn. The new RCF will also be available to repay, if necessary, the EUR250m convertible bonds in 2018 should they not convert at that time.

Operating Performance Improving

We believe the improving trend in performance delivered since 2014 should be maintained in 2016 as refurbishments should allow healthy increases in average room rates, albeit slower than in 2015. 1H16 results showed a firm EBITDA margin increase, as revenue per available room (RevPar) reported reasonably good growth (up 6.7% yoy). Encouragingly, average room rate increases (2015 prices up 8.3%) were well above those derived from increased occupancy (+0.6%), confirming the gradual move away from lower-margin tour operator bookings.

Refinancing Improves Capital Structure

The new EUR285m 2023 senior secured notes extend and simplify the existing debt maturity profile of the group. Following completion of the refinancing the group has a simple capital structure comprising essentially senior secured bonds, a senior secured RCF facility and a convertible bond issue.

Growing Upscale Presence

NH's expansion and development plan includes the development of a further 23 NH Collection four-star plus hotels, which should increase the portfolio to a total of around 73 hotels and 11,500 rooms by end-2017 (or a little under 20% of all rooms). Overall NH Collection hotels deliver an average daily rate (ADR) of around 40% more than a normal NH Hotel. This upscale hotel format underpins our estimate of EBITDA growth from 2016 to 2018.

Attractive Hotel Portfolio

The majority of NH's properties are in or around major European and Latin American cities (88% urban, 12% resort hotels). As a result, the portfolio's valuation (EUR1.8bn at end-2015) has proven resilient and become a primary source of liquidity in recent years. The properties further benefit the group by serving as collateral for its secured debt.

Evolving Lease Liabilities

During 2015 the group terminated leases and renegotiated lease contracts, resulting in an annual net saving (before new leases of EUR5m on new hotels) of around EUR7m p. a. This process should continue for the rest of 2016, ensuring leases remain stable as a percentage of revenues at around 20%, but still high compared with peers (Accor 15% in 2014).

Improving Leverage

Leverage is compatible with levels in the 'B' category and we expect some deleveraging in 2016. We expect Fitch FFO lease-adjusted net leverage to reduce to around 7.1x by end-2016 and 6.6x by end-2017, although this remains high compared with peers such as Accor and Whitbread. The high capex of recent years should, however, reduce and allow free cash flow (FCF) to turn positive in 2017. This is despite the group's plan to start paying a dividend from 2017 onwards, which will limit the scope for deleveraging.

Gradual Shift to Online

At end-2015 around 50% of bookings were through direct channel (i. e. own website and mobile applications) against third-party website bookings. Given that the percentage split between direct and indirect sales is unlikely to change in the next couple of years, NH's strategy is to both reinforce direct distribution channels and optimise indirect channels and focus on the net average daily rate achieved.

Strong Expected Recoveries

The 'RR2' on NH's existing and new senior secured notes reflects Fitch's expectations that the valuation of the company - and the resulting recovery rate for its creditors - will be maximised in a liquidation due to the significant value of the company's owned and unencumbered real-estate portfolio (estimated at EUR965m at end-June 2016). We also assume a fairly conservative 7x multiple in a distressed scenario.

The 2019 and 2023 notes benefit from security over assets and share pledges, as well as a pari-passu clause with other secured debt, including the new RCF.

Successful Asset Disposals

NH sold the Sotogrande estate for EUR178m in 2H14, EUR33m of assets in 2015 and a further EUR76m of assets in 1H16. This has improved financial flexibility, allowing for further debt repayment or funding of capex. NH plans to sell a total of EUR140m of hotel assets in 2016, reflecting NH's continued push to get rid of underperforming or non-core assets. In this respect NH is exploring various scenarios for its NH New York Jolly Madison Hotel.

Moving towards Asset-Light

The asset sales demonstrate NH's move to increase the portion of the overall portfolio under a "managed" format against the "owned" structure currently in place. NH has increased the properties under management to 24% of total portfolio at end-2015 from 13% in 2008. This changed business model combines the benefits of lower capex needs with a reduction in the volatility of profits. Nevertheless the group remains an asset-heavy/leased business model, rather than the asset-light hotel business profile common in the US.

Improving Cash Generation from Operations

NH's Fitch-estimated unrestricted cash was EUR43m at end-2015 and EUR51m at end-June 2016, down from EUR165m at end-2014, as a result of the higher capex and the acquisition of the Colombian hotel group, Hoteles Royal, for a net EUR66m during 2015.

Capex to reposition the group's hotels and upgrade the IT network in 2016 will remain high at around 11% of revenues p. a. and will drain operating cash, but should mostly be covered by asset disposals. However, with lower capex requirements in 2017 we expect FCF to turn positive and, combined with the new RCF, should materially improve group liquidity and financial flexibility.

Shareholder Dispute

In June 2016, the board of NH voted off four board representatives from major shareholder (29.5%) Chinese group HNA, citing possible conflicts of interest due to HNA's acquisition of competitor Carlson Hotels Inc. HNA has now sued NH and is asking for the suspension of these resolutions, but a Spanish Court has recently ruled that the interim measure requested by HNA has been rejected. We have not factored into our rating any risk of adverse consequences on NH's strategy from this dispute but will treat it as an event risk.

KEY ASSUMPTIONS

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

-Occupancy and ADR growth lower than management's forecasts, particularly from 2017 onwards. We expect 2016 and 2017 RevPar increases to be more moderate than in 2015.

-Under our rating case management efforts to limit cost increases will be partly offset by rising salaries as economic conditions in Spain and Italy slowly improve.

-Operating lease costs from 2016 to 2018 of between EUR299m and EUR334m p. a..

-Capex is modelled in line with management's projections (ie for 2017 and 2018 between EUR80m and EUR90m p. a.), reflecting that around 60% of repositioning spending would have been completed by end-2015 and around 100% by end-2016.

-Hoteles Royal's revenue and operating profits are included from 2016 onwards.

-Deferred payment for Hoteles Royal hotels of EUR20m in 2017.

-Dividends to restart at a modest level from 2017.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:

-Improved trading performance leading to group EBITDA margin (excluding one-off gains) of 12% or above on a sustained basis.

- FFO lease-adjusted net leverage below 6.5x on a sustained basis.

-EBITDAR/(gross interest +rent) above 1.8x or FFO fixed charge cover above 1.5x (2015: 1.2x) on a sustained basis

-Sustained positive FCF.

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

-Weakening trading performance leading to group EBITDA margin (excluding one-off gains) of 10% or below on a sustained basis

-FFO lease-adjusted net leverage at 7.0x to 7.5x (2015: 7.7x) on a sustained basis in 2017 and thereafter.

-EBITDAR/(gross interest +rent) sustainably below 1.3x or FFO fixed charge cover below 1.1x.

-Sustained negative FCF.

LIQUIDITY

With the signing of the EUR250m RCF NH has significantly enhanced its liquidity profile, allowing this asset-heavy group some reasonable operational and financial flexibility. The new RCF is expected to be undrawn at closing and will provide a healthy liquidity buffer. The capital structure will be simplified further to comprise the new EUR285m 2023 bond, with the repayment of smaller club deals, individual mortgages and other small amount debt.