OREANDA-NEWS. Fitch Ratings has affirmed NH Hotels Group SA's (NH) Long-term Issuer Default Rating (IDR) at 'B-' and NH's EUR250m 2019 senior secured notes at 'B+'/'RR2.' The Outlook on the Long-term IDR is Stable.

Fitch has also assigned NH's planned EUR200m 2022 senior secured notes an expected senior secured rating of 'B+(EXP)' with an expected Recovery Rating 'RR2.' The final rating is contingent upon the receipt of final documents conforming to information already received.

NHH's ratings are supported by its improving operational profile, with some geographical diversification outside its core Spanish and European urban hotel market. They also take into account the company's substantial hotel asset base, valued at EUR1.6bn at FYE14, including EUR600m of unencumbered assets. The ratings are further underpinned by the successful financial restructuring in 2013 and additional cash inflow from asset divestments in 2014.

The ratings are constrained by the past under-investment in the hotel portfolio, which now requires substantial capex investment to upgrade the hotel stock to current standards. This will mean further material cash outflows in 2015 and 2016, which will constrain financial flexibility that is already hampered by high leverage (FFO lease adjusted net leverage of 8.4x at FY14).

KEY RATING DRIVERS FOR THE NOTES
Fitch has conducted a bespoke recovery analysis for the new senior secured notes' rating. Fitch considers that expected recoveries upon default would be maximised in a liquidation scenario, rather than in a going-concern scenario, given the significant value of the company's owned real estate portfolio. Taking into account the new debt structure -after the notes' issuance, and following a strict payment waterfall, Fitch estimates that the recovery rate for the EUR200m senior secured notes would fall within the 'RR2' range given country cap constraints, leading to their rating being two notches above NH's IDR.

KEY RATING DRIVERS for the IDR
Operational Performance Improving
NH's FY14 results showed much faster revenue per available room (RevPar) growth at 3.6% on a like-for-like basis, underpinned by price increases (+1.7%) following increasing hotel refurbishments and further increase in occupancy (+1.9%) driven by a recovering Spain, Italy and Latin America. Fitch expects NH to continue to benefit from both further increases in Average Room Rates (ARR) in 2015 (+1.6%) driven by a more competitive room portfolio, and stable occupancy rates driven by improved consumer confidence. The recent acquisition of Hoteles Royal should also support revenue growth over the next two years.

Attractive Hotel Portfolio
The majority of NH's properties are in or around major European and Latin American cities. A substantial maintenance and enhancement capex programme is underway to bring hotels up to its direct competitor standards As a result, the hotel portfolio's valuation (EUR1.6bn at FY14) has proven resilient and become a primary source of liquidity in recent years. Of the total hotel portfolio valued at EUR1.6bn at FY14, the unencumbered hotel asset base is valued at EUR0.6bn at FYE14.

Leverage Remains High
NH's capital structure at end-2014 has benefited from asset divestments, such as the Sotogrande disposal and reduced lease charges from renegotiations. Total debt reduced to EUR807m from EUR880m at FYE13. Fitch expects gross debt to increase post-refinancing to around EUR870m in FY15, although NH's improving operational profile and the expected increase in operating cash flows should help the group maintain FFO net adjusted leverage around 7.6x over the next two years.

Portfolio Optimisation
The on-going portfolio optimisation is aimed at exiting non-strategic or non-profitable hotels and adding new strategic hotels. This will result in annual savings and should also improve the quality of NH brands. Fitch expects the portfolio change as well as the asset repositioning plan to help NH improve its ARR over the next two years. The re-positioning plan involves converting existing hotels into upscale NH Collection Hotels.

Liquidity and FCF Position
Available cash will remain limited in 2015 and 2016 mainly due to the heavy investment to refurbish and upgrade the hotels (EUR154m or nearly 10% of portfolio value). This is to make up for the consistent capex underinvestment between 2010 and 2012. As a result and despite improving operational performance, Fitch expects free cash flow to remain negative in 2015 and 2016. Post-refinancing, NH will extend its debt maturity profile and alleviate pressure on its liquidity.

Weak Credit Metrics
Leverage and FFO cover remain firmly in the lower 'B' category with deleveraging likely to be modest over the medium term. With Fitch-estimated FFO net adjusted leverage of around 7.6x at FYE15, NHH's leverage compares weakly with other rated hotel and leisure peers such as Accor (BBB-/Stable) and Whitbread (BBB/Stable). As Fitch does not expect significant deleveraging over 2016 and 2017 due to cash being allocated to capex, NHH's credit metrics will remain a constraint on the ratings.

KEY ASSUMPTIONS
-Revenue growth is driven by improved ARR on the back of management initiatives to optimise its hotel portfolio and capacity expansion.
-EBITDA growth is driven by improved pricing and management's efforts to control costs.
-Operating leases: we expect a small gradual increase in lease costs because of management's plan to increase leases' share of rooms operated to 57% in 2018 from %-54% in 2014.
-Capex includes mainly maintenance capex (EUR59m) and repositioning capex (EUR94m in 2015 and EUR60m in 2016).
-Acquisition of Hoteles Royal in 2015 for EUR48m and a deferred EUR18m in 2017.

RATING SENSITIVITIES
Positive: Future developments that could lead to positive rating action include:
-Improved trading performance leading to group EBITDA margin (excluding one-time gains) sustained at or above 10%.
-Lease adjusted net debt (including non-recourse securitisation)/ EBITDAR below 6.5x or FFO lease-adjusted net leverage below 7.0x on a sustained basis.
-EBITDAR/gross interest + rent sustainably above 1.5x.
-Demonstrate a path to sustained positive free cash flow.

Negative: Future developments that could lead to negative rating action include:
-Weaker operational cash flows leading to higher continued free cash outflows and resulting in strained liquidity.
-Lease-adjusted net leverage above 9.0x.
-Group EBITDA margin excluding capital gain below 6%.
-EBITDAR/(rent + interest) below 1.1x.