Fitch Affirms Arauco's IDRs at 'BBB'; Outlook Revised to Negative
The revision of the Outlook to Negative reflects Fitch's base case projections that Arauco's net leverage will remain above 3.0x in 2016 and 2017, which is materially higher than previously projected since it includes about two years of full operations of the Montes del Plata pulp mill. Despite higher pulp sales volume, the company's results were impacted negatively by strengthening of the U. S. dollar, soft pulp prices and weaker demand from the panel division. If net leverage falls to below 3.0x during 2017, the Negative Outlook would likely be revised to Stable.
KEY RATING DRIVERS
Strong Business Position
Arauco's ratings are underpinned by its strong business position, as the second-largest market pulp company in the world. Arauco has one of the lowest cost-structures in the industry, which allows it to generate strong operating cash flows during market downturns. The company is also the second largest producer of panels in the world and has a strong presence in the lumber market. Arauco's competitive cost advantages in these products are viewed to be sustainable because of its productive forest plantations, modern production equipment, energy self-sufficiency, and low transportation costs due to the close proximity of its plantations, mills, and ports.
Elevated Leverage
Arauco's adjusted net debt/EBITDA and total debt/EBITDA ratios for the LTM ended June 30, 2016 were 3.6x and 4.0x, respectively, per Fitch's calculation, and are not consistent with our expectation of fast deleveraging post start-up of the Montes del Plata pulp mill in 2014. Both ratios increased over the year-end net debt/EBITDA of 3.2x and total debt/EBITDA of 3.6x and remain elevated for the rating level. Fitch's base case projects net leverage at around 3.5x in 2016, decreasing to about 3.3x in 2017. These assumptions consider low-cycle net price assumptions for hardwood and softwood pulp of between USD550 and USD625 per ton during the next three years. Arauco had USD4.6 billion of total debt at the end of June, which included USD618 million of debt at its Montes del Plata pulp joint venture, and compares to USD4.5 billion at the end of 2015 and USD5.2 billion at the end of 2014.
Weak Operating Cash Flow
Fitch projects that Arauco will generate about USD1.1 billion of EBITDA in 2016. This figure compares negatively with USD1.2 billion in 2015. Arauco's cash flow from operations has declined to USD867 million for the LTM ended June 30, 2016 from USD997 million during 2014 despite the startup of its new pulp mill. Positively, Arauco's free cash flow (FCF) improved to USD337 million due to a decline in capex. Although negative from a creditor's perspective, the company used its cash generation to acquire 50% of Tafisa (Spain), a subsidiary of Sonae Industria (Portugal), for Euro137.5 million (about USD153.1 million) in May 2016. With this acquisition, Arauco will have its first operating facilities in Europe and South Africa, with an annual production capacity of 50% of 4.2 million m3 of panels. Arauco will not consolidate this subsidiary nor guarantee its debt, and dividends are not expected in the short term.
Significant Forestry Investments
A key credit consideration that continues to support Arauco's investment-grade credit profile is its significant forestry holdings. The company owns about 1.7 million hectares of land throughout Chile, Brazil, Argentina and Uruguay. Forest plantations have been developed on about 1 million hectares of this land. While the company does not intend to monetize them, the plantations are valued at USD3.8 billion. Importantly, the nearly ideal conditions for growing trees in the region make these plantations extremely efficient by global standards and give the company a sustainable advantage in terms of cost of fiber.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Arauco include:
--Pulp sales volume between 3.6 million tons and 3.8 million tons.
--Hardwood prices between USD550 and USD600 per ton during 2016-2017.
--USD620 million CAPEX in 2016 and USD670 million in 2017.
--CFFO between USD750 million and USD900 million in 2016-2017.
RATING SENSITIVITIES
Future developments that may individually or collectively lead to a negative rating action include:
--An expectation that net leverage will remain above 3.0x during 2017, considering pulp prices remain relatively unchanged;
--Any change in the company's strategy to reduce leverage and improve capital structure;
--A key variable as to whether Arauco's leverage remains below this level will be a conservative approach to capex and acquisitions. If the company proceeds with its MAPA project without improving its balance sheet or receiving additional support from its parent company, Empresas Copec, a negative rating action is likely.
A rating upgrade for Arauco is not likely in the near future.
LIQUIDITY AND DEBT STRUCTURE
Arauco has an adequate liquidity position. As of June 30, 2016, the company had USD527 million of cash and marketable securities and total debt was USD4.6 billion. Additionally, Arauco has two committed credit lines not used, totaling USD320 million and due in 2020. The company has a manageable debt maturity profile, with USD297 million of financial debt falling due in the second half of 2016, USD541 million in 2017, USD434 million in 2018 and USD655 million in 2019. As of June 30, 2016, total debt was composed mainly of senior notes in U. S. dollars (51% of total debt), bonds in UF (21%), and bank loans (22%).
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
--Long-Term Foreign and Local Currency Issuer Default Ratings at 'BBB';
--Long-term national scale rating at 'AA-(cl)';
--Senior unsecured international debt at 'BBB';
--Senior unsecured national debt at 'AA-(cl)'.
The Rating Outlook is revised to Negative from Stable.
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