Fitch Affirms Gerdau's IDRs at 'BBB-'; Outlook Remains Stable
The affirmation reflects Gerdau's low cost structure, well-developed network of scrap procurement, geographical diversification, and ability to generate positive free cash flow (FCF) during periods of difficult operating conditions.
KEY RATING DRIVERS
Geographically Diversified Operations a Key Strength:
Gerdau's investment grade ratings are supported by the company's position as the leading geographically diversified long-steel producer in the Americas, which cushions revenues from volatility associated with exposure to any one single country. As of the first quarter of 2015, the company's LTM EBITDA of BRL4.7 billion was split by operations as follows: North America 21%, Brazil 49%, Latin America (excluding Brazil) 9% and Specialty Steel (including Europe) 20%. The company also has a flexible production cost structure with 75% of output coming from minimills, which allows the company to close and open facilities quickly in response to market conditions.
Commitment to Solid Capital Structure:
The affirmation takes in consideration an expectation by Fitch, which is based upon past actions by the company, that Gerdau would sell assets or raise equity if market conditions remain weak to bolster its capital structure. During 2011, the company issued equity to bolster its capital structure following a substantial decline in steel demand globally. The stability in Gerdau's credit metrics can be seen in the company's five-year rolling average funds from operations (FFO) adjusted leverage ratio of 3.5x, which compares well to its global peers. Its five-year rolling average net debt/EBITDA ratio was 2.6x for 2010-2014.
Deterioration in Leverage Ratios:
Fitch projects that net leverage will exceed 2.5x during the next two years, before declining in 2017. Gerdau's leverage metrics deteriorated during the last quarter due to the depreciation of the BRL and its impact on gross debt, as well as weak steel demand in Brazil. Gerdau's net debt-to LTM EBITDA ratio was 3.8x as of March 31, 2015. The company has stated its strategic plan to reduce its net leverage to below 2.5x in the medium term through a combination of improving SG&A costs, reductions in capital expenditures, and asset optimization measures.
Positive Free Cash Flow:
Gerdau's ability to generate positive FCF during periods of significant investments or difficult trading conditions also supports the company's investment-grade ratings. Adjusting for cash flow movements related to trading securities, Gerdau had positive FCF of BRL333 million in 2014 and BRL1.9 billion in 2013. The company generated FFO of BRL3.9 billion and CFFO of BRL3.9 billion during the last 12 months ended March 31, 2015. Fitch projects Gerdau will generate lower CFFO during 2015 and 2016 due to the weak operating environment; however, FCF is projected to remain positive over the next 4-5 years due to strong working capital management, reduced operating costs, and lower capex.
Scope for Increased Exports:
Devaluation of the Brazilian real (BRL) has restored a degree of global competitiveness to Brazil's steel industry. Combined with relief from lower raw material costs, local players have re-entered the export market. Brazil has been a net importer of flat and long steel since 2010, although this trend could begin to reverse in 2015 if steel tariffs remain at 12% and the BRL remains weak. Fitch expects Gerdau's Brazilian operations to consist of approximately 20% of exported steel in 2015, which compares to 11%-13% of Brazilian net sales over the last two years. This will offset a portion of the volumes lost in the domestic market, however increased exports will negatively impacted profitability, as Gerdau's domestic Brazilian EBITDA margins are around 18% compared to the export market of 5%-12% EBITDA margins.
KEY ASSUMPTIONS
--12% decline in steel volumes sold in Brazil
--Flat prices in 2015;
--5% decline in specialty steel market;
--EBITDA margin between 10.5%-11% for 2015;
--Strong liquidity position maintained during 2015-2018.
RATING SENSITIVITIES
A downgrade or change in Outlook could occur following a fundamental change in the import tariffs on steel in Brazil, persistent negative FCF generation, a sustained EBITDA margin below 10%, and/or net leverage above 3.0x over the next two years.
An upgrade or Positive Outlook could be considered following a significant improvement to Gerdau's credit profile, with a net debt/EBITDA ratio at around 1.5x alongside consistently strong FCF generation, in addition to optimizing and improving its competitive position globally.
LIQUIDITY AND DEBT STRUCTURE
Gerdau has low refinancing risk with a debt average life of 6.9 years as of March 31, 2015. The company's cash plus FCF-to-debt service coverage ratio was 2.2x for the LTM ended March 2015. Fitch expects the company to maintain a minimum cash balance of around BRL3 billion-BRL4.5 billion providing the company with comfortable liquidity headroom. In addition to its cash balance, Gerdau has access to a global revolving credit facility (RCF) totalling BRL4.8 billion (BRL813 million outstanding as of Dec. 31, 2014) with large, multinational banks. As of March 31, 2015 Gerdau held over BRL5.8 billion in cash and marketable securities, with 41.3% of this cash held by Gerdau companies abroad and denominated mainly in U.S. dollars. Cash equivalents were mainly held in deposit accounts with immediate liquidity.
Gerdau has two financial covenants that apply to around USD1.6 billion of the company's debt or approximately 22% of its total debt of USD7.3 billion. One covenant is a net debt-to-EBITDA ratio test of less than 4.0x. Under Fitch's Base Case scenario, Gerdau comfortably meets this test level requirement.
FULL LIST OF RATING ACTIONS
Fitch affirms Gerdau's ratings as follows:
--Foreign currency IDR at 'BBB-';
--Local currency IDR at 'BBB-';
--National long-term rating at 'AA+(bra)'.
--Gerdau Holdings Inc. 7.00% notes due 2020 at 'BBB-';
--Gerdau Holdings Inc. 5.893% notes due 2024 at 'BBB-';
--Gerdau Trade Inc. 4.75% notes due 2023 at 'BBB-';
--Gerdau Trade Inc. 5.75% notes due 2021 at 'BBB-'
--GTL Trade Finance Inc. 7.250% notes due 2017 at 'BBB-';
--GTL Trade Finance Inc. 7.250% notes due 2044 at 'BBB-';
--GTL Trade Finance Inc. 5.893% notes due 2024 at 'BBB-' ;
--Port Auth of the City of St Paul (MN) Solid Waste Disposal Revs (Gerdau) 2012-7 'BBB-'.
The Rating Outlook is Stable.
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