OREANDA-NEWS. Fitch Ratings has affirmed Office Depot de Mexico S.A. de C.V.'s (ODM) Issuer Default Rating (IDR) at 'BB+'. The Rating Outlook is Stable.

The ratings reflect ODM's leadership position in the office products super-store segment, diversified geographical footprint and consistent cash flow generation. The rating also incorporates a leverage of about 3.5x adjusted debt-to-EBITDAR and debt-to-EBITDA of 2.5x, in the medium term. The ratings are tempered by currency mismatch between debt and cash flows, despite debt service being hedged until 2017.

KEY RATING DRIVERS

STRONG BUSINESS PROFILE
ODM's operating profile is supported by its national retail presence in Mexico, as well as its operations in Central and South America, its mix of large corporate customers, small businesses and consumers. It has a leading position among Mexican office supply super stores, while non-Mexican sales represent about 15% of total revenue. In addition, its wide distribution network, preponderance of cash sales and mostly local sourcing of inventory, further supports ODM's business profile.

STABLE CASH FLOW GENERATION
The company has shown consistent growth over the past 12 years, with solid EBITDA generation even during economic downturns. Same store sales (SSS) fell -1.4% in 2014, in part due to uneven consumer confidence, while total sales increased by 7.5%, due to the acquisition of Casa Marchand, a niche office and school supplies retailer. Over the same period, EBITDA margins declined by 43 basis points (bps) compared to full year 2013, a result of Marchand's lower margins. SSS declines seem to have been reverted, as for the first six months of 2015, SSS grew 5.2% on a Year to Date (YTD) basis. EBITDA margin been broadly stable, at 10.5% for the second quarter of 2015 (2Q'15) on a last 12 months (LTM) basis, but EBITDA generation is expected to be around MXN2 billion pesos for full year 2015, driven mostly by ODM's recent acquisitions. Going forward, Fitch expects ODM's EBITDA margin to be around 10%.

GROWTH THROUGH TARGETED ACQUISITIONS
ODM has recently acquired Grupo Prisa (PRISA), a Chilean office supply company, as well as RadioShack de Mexico (RSdM). These acquisitions increase revenues around 30% on a pro forma basis. Fitch believes that Prisa adds geographical diversification to ODM, while RSdM could see improved margins and market share under ODM's stewardship. The Mexican office supply and small electronics retail industry is very fragmented, with the potential for consolidation by big players such as ODM. Going forward, ODM will also pursue a robust growth strategy, with an estimated 40 store openings per year on average. Fitch expects these openings and any upcoming acquisitions to be funded with internally generated cash flow, as the company has done in the past.

LEVERAGE TEMPORARILY ABOVE EXPECTATIONS

The ratings include expectations that ODM's adjusted debt to EBITDAR leverage should be around 3.5x (debt-to-EBITDA: 2.5x) in the medium term. For June 30, 2015 LTM, adjusted debt to EBITDAR was 3.9x, (debt to EBITDA: 3.0x). Excluding the effect from the U.S. dollar's appreciation against the Mexican peso over the last 12 months, 2Q'15 leverage would be 3.5x adjusted debt-to-EBITDA (2.5x debt to EBITDA). Leverage is expected to improve as SSS stabilize, and EBITDA generation and margin improvement from the recent acquisitions occurs. While Fitch envisions short-term deviations from its expected leverage levels due to strategic initiatives, sustained leverage levels above expectations will continue to add pressure to the ratings.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for ODM include:

--EBITDA margin around 10%;
--Debt is kept broadly constant in dollar terms;
--Most revenue growth in the short-term to come from recent acquisitions.

RATING SENSITIVITIES
Factors that could be detrimental to credit quality include weaker-than-expected SSS, lower EBITDA margin, debt-financed acquisitions, further devaluation of the Mexican peso vs. the U.S. dollar, or other factors that could lead to sustained leverage levels above 3.5x adjusted debt to EBITDAR and 2.5x debt to EBITDA in the medium term.

Factors that could improve creditworthiness include stronger-than-expected operating results or lower debt levels that lead to adjusted debt-to-EBITDAR ratios below 2.5x and 1.6x debt to EBITDA, as well a commitment from a financial policy standpoint to permanently maintain leverage at this lower level.

LIQUIDITY
With cash of MXN559 million as of 2Q'15 and no material debt maturities until 2020 (aside from MXN83 million short-term debt, incurred by Prisa before the acquisition), ODM's liquidity position is manageable. Free cash flow (FCF) before dividends has been mostly positive over the past five years, and Fitch expects modest pre-dividend FCF generation going forward, with Capex around MXN800 million per year in the medium term. Aside from the shareholder loan to Grupo Gigante and its related non-cash shareholder dividends, ODM is able to pay cash dividends in an amount of up to 50% of net income according to covenants. Given this, Fitch would expect for cash to accumulate and to possibly be used for gross debt reduction.

Fitch has taken the following rating actions:

Office Depot de Mexico, S.A. de C.V.
--Foreign currency long-term IDR at 'BB+';
--Local currency long-term IDR at 'BB+';
--USD350 million senior notes due 2020 at 'BB+'.