OREANDA-NEWS. Fitch Ratings has affirmed the following ratings of Arendal, S. de R.L. de C.V. (Arendal):

--Foreign currency long-term Issuer Default Rating (IDR) at 'B';
--Local currency long-term IDR at 'B';
--USD100 million senior unsecured notes due 2016 at 'B/RR4'.

The Rating Outlook has been revised to Negative from Stable.

The Negative Outlook reflects weak external market conditions for debt refinancing of high yield issuers that make the company more dependent in its ability to attract alternative sources of financing. Company management is looking at multiple options for refinancing its notes due 2016. Receiving payment in a timely manner of a good portion of accounts receivable would enhance its ability to attract funding and improve the financing profile of new and existing projects. Successful debt refinancing and funding of operations through a combination of internal and external sources would likely result in the Outlook being revised to Stable.

Arendal's ratings are supported by the company's track record and technical experience in the Mexican heavy construction industry as a recognized player in the construction of fluid transportation systems and plants, its participation in both public and private sector projects across Mexico, and its positive operating performance despite a challenging economic environment. Conversely, the ratings are limited by the characteristics of the industry, which is highly linked to economic cycles, project concentration of revenues and cash flow, high and mostly short-term debt levels as well as the current process of institutionalization and adoption of corporate governance practices.

The expected recovery ratings of 'RR4' reflect average recovery prospects given default. 'RR4' rated securities have characteristics consistent with securities historically recovering 31%-50% of current principal and related interest.

KEY RATING DRIVERS

Weak Liquidity Would Trigger Downgrade
Arendal's management expects to complete and collect receivables and consortium inflows for a significant amount of key projects by the fourth quarter of 2015. Current ratings build in an expectation that absent significant progress toward refinancing the 2016 notes by the third quarter of 2015, liquidity would need to be significantly above current levels and net debt/EBITDA ratio at or below 3.6x by year-end 2015 to avoid a rating downgrade.

Arendal's cash balance at year-end 2014 was MXN923 million, similar to MXN969 million of short-term debt maturities and within Fitch's previous expectations. Free cash flow (FCF) was negative MXN2.106 billion underperforming Fitch's expectations, largely due to higher working capital requirements. The company's 2014 working capital cycle, as measured by Fitch, increased to 170 days from 57 days at year-end 2013 due to a combination of account receivables collection delays and lower payables financing. In Fitch's view, receiving payment in a timely manner of accounts receivable would improve company liquidity and enhance its ability to obtain additional funding.

High Leverage
Total debt including leases as of Dec. 31, 2014 was MXN3.137 billion, 34% of which was guaranteed by project cash flows, reflecting the company's higher proportion of unsecured debt after the May 2014 notes issuance. Although this total debt level is in line with Fitch's previous expectations it is significantly above the agency's long-term total debt/EBITDA leverage expectation in the range of 4.5x to 5.0x for the company's current ratings.

Short-Term Debt Financing
Arendal's financing strategy has been primarily to raise new debt after securing a project, allowing the company to match debt payments with specific project revenues. Given that most projects have periods of completion that range between 18-24 months, financing tends to be short term, resulting in high levels of short-term debt. Liquidity and profitability depend on timely collection of accounts receivable and to a lesser extent on the availability of credit lines or alternative financing to support working capital needs.

Relevant Business Position
The company has a significant business position in the construction of pipelines when measured in kilometers built during the last few years. Arendal engages primarily in project contracts that include full or partial engineering, procurement and construction of pipelines and plants. Also, the company has the capacity to execute projects across all of the Mexican territory and to efficiently manage its technical and workforce resources. Arendal's competitive advantage among industry peers includes a historical project completion rate of 98% before or on settled dates. Fitch considers that these elements can contribute to Arendal maintaining its business position in the long term.

Project Concentration Risk
Arendal has gained increasingly larger projects which have helped the company grow rapidly, but this growth has come with large-project concentration risks. A single large project can at times represent 40% of revenues or more. Additionally, the company's revenue mix is significantly oriented toward the public sector. During 2014, Arendal generated 51% of its revenues from contracts with Pemex. Considering the available backlog, revenues from Pemex as the ultimate client will likely continue to represent a large portion of the company's revenue source.

In June 2014, Arendal signed a contract with TAG Pipelines Norte for engineering, procurement & construction services of the Ramones II Norte project, a portion of a larger project aiming to increase the supply of natural gas in Mexico through the construction of a pipeline system extending from the U.S. border city of Camargo, Tamaulipas to El Alto, Guanajuato. In October 2014, Arendal in conjunction with a subsidiary of Foster Wheeler AG was awarded a contract for the construction of an ultra-low sulfur diesel project (DUBA) in Pemex Refinacion Salina Cruz refinery. These contracts reflect positively on management's continued ability to bid for and secure projects. Fitch conservatively estimates Arendal's current backlog, excluding Los Ramones and the Duba projects, at over 1.2x 2014 sales.

Fast-Growing Resilient Operations
In the last five years, the company has continued to grow organically. As of Dec. 31, 2014, the company has more than quadrupled its yearly revenues to MXN3.953 billion from the MXN952 million pre-crisis levels in 2007. Compounded annual growth rate (CAGR) of revenues and operating income for the last five years ended Dec. 31, 2013 was 39% and 46%, respectively. These factors, in Fitch's opinion, reflect management's ability to adjust its operating and business strategies depending on economic environment, and also reflect management's ability to bid for, secure and execute larger size contracts.

Recovery Prospects
In Fitch's opinion, under a stress scenario recovery of debt instruments associated with pledged contracts would have access to the existing accounts receivable to cover outstanding debt; the remaining balances would form part of the mass of unsecured creditors with average prospects of recovery between 31%-50%.

KEY ASSUMPTIONS

--Flat to low single digit revenue growth for 2015; modest revenue growth for the following years.
--Flat to positive working capital flows for 2015 modest working capital outflows to support growth.
--No dividend payments.
--Access to bank lending.

RATING SENSITIVITIES

The ratings could be negatively pressured by a combination of the following factors, among others:

--Limited access to financing sources affecting the company's liquidity position.
--Further delays in collectability of receivables that pressure cash flow.
--Deterioration of Arendal's credit metrics beyond current expectations as a result of higher than expected competition which pressures operating performance.

Factors which could lead to positive rating actions include:

Lower project concentration, high level of repeat business or service type contracts in conjunction with strong credit metrics, liquidity, and full implementation of corporate governance practices.