Fitch Affirms Hypermarcas' IDRs at 'BB ; Outlook Remains Positive
The maintenance of the Positive Outlook reflects Fitch expectation that Hypermarcas should succeed in lowering its net leverage ratio to approximately 2x in the next 18-24 months. The changes in the company's business strategy have pressured its internal cash flow generation over the last few years and slowed this process. Going forward, a more steady strategy should finally be achieved and a likely more solid ability to generate robust free cash flow (FCF) is expected.
KEY RATING DRIVERS
Hypermarcas' ratings reflect its leading position in the competitive Brazilian pharmaceutical and consumer market, the strength and diversification of its brands and the resilience of its product portfolio. The company's low ticket and less discretionary consumer products supports the defensive nature of its portfolio and is a key factor supporting its business fundamentals in a sluggish macroeconomic scenario. The ratings also incorporate Hypermarcas' moderate leverage and robust liquidity position.
Strong Business Position
Hypermarcas has one of the largest and most diversified consumer products portfolios in Brazil, fosucing on the pharmaceutical, beauty and personal care segments. The company's strategy includes capturing synergies through the integration of its pharma and consumer businesses into a lean cost platform in terms of packaging, distribution, advertising and marketing. Currently, the company's pharma segment accounts for 55% of revenues, while the consumer segment accounts for 45% of revenues. The pharma business is by far the most profitable segment, accounting for approximately 68% of gross profit. The resilience of Hypermarcas' business is evidenced by the solid growth of its operations during 2015, in high single digits despite the economic recession in Brazil.
Recurring Changes in Business Strategy Adds Volatility to Cash Flow from Operations
Hypermarcas' recent strategy of bolstering market-share and increasing demand through its lower value-added products portfolio has limited operating margin improvements. It has also resulted in the need for high inventory levels and weaker sales terms, which has increased working capital requirements and pressured cash flow from operations. During the last 12 months (LTM) ended June 30, 2015, Hypermarcas' EBITDA reached BRL1.14 billion, a modest increase from BRL1.1 billion in 2014 and BRL1 billion in 2013. The company's EBITDA margin remained relatively flat at 23.1%.
Limited FCF Expansion; Improvement Expected
During the LTM ended June 30, 2015, Hypermarcas' funds from operations were BRL461 million, while CFFO generation was quite poor at only BRL69 million. CFFO was pressured by BRL391 million of working capital needs and BRL371 million of interests paid. As a result, in the same period free cash flow was negative by BRL120 million. These figures compare negatively with CFFO of BRL267 million and positive FCF of BRL89 million during 2014. Going forward, Fitch expects Hypermarcas to maintain a strategy focused on market-share. For 2015, Fitch projects that the company will generate about BRL1.2 billion of EBITDA and BRL263 million of CFFO, resulting in BRL65 million of FCF. For 2016, the agency expects these figures to improve as a result of lower working capital needs, allowing for FCF of around BRL100 million.
Deleveraging Trend Still Expected
Hypermarcas' poor CFFO generation was also associated with higher interest rates. As of the LTM ended June 30, 2015, the company's net debt/EBITDA ratio was 3x, which is below the average of 3.5x in the period 2011-2014, but above Fitch's expectation to reach close to 2x during 2015. Net leverage is expected to reach 2.6x at the end of 2015 and 2.3x by 2016. In Fitch's view, Hypermarcas' creditors could benefit from a potential asset sale of the disposable products segment, which could also accelerate the deleveraging trend if the company uses the resources to amortize debt.
KEY ASSUMPTIONS
--Revenue growth in the high singledigit range in 2015, and remaining above 6% in the next three years,
--EBITDA margin decline to around 22% due to inflation, weaker product portfolio and the impact of the strong U.S. dollar on costs;
--Improvements in working capital needs, declining to around 5% of net revenues;
--BRL180 million of maintenance capex going forward;
--Dividends of 25% Net Income only from 2017 on;
--No acquisitions or asset sale.
RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
--Sale of the disposable products segment;
--Operating margins consistently around 23%;
--Solid recovery in CFFO generation (above 8% CFFO margin);
--Positive FCF generation above BRL130 million;
--Net adjusted leverage below 2.2x, ona consistent basis;
--Maintenance of strong liquidity position, with cash/short-term debt above 1x on a consistent basis.
Negative: Future developments that may, individually or collectively, lead to a negative rating action:
--EBITDA margins falling and remaining below 20%;
--Net adjusted leverage above 3.5x;
--Deterioration of sound liquidity of short-term debt, with cash/short-term debt below 1x on consistent basis, leading to refinancing risk exposure;
--Large M&A acquisition that moves the company's leverage beyond 3.5x, on a sustainable basis.
LIQUIDITY
Hypermarcas has a track record of keeping strong cash balances, with cash covering short-term debt by an average 1.7x during the last five years. As of June, 30 2015, the company had BRL5 billion of debt, of which BRL1.7 billion is due in the short term, while cash and marketable securities was solid at BRL1.6 billion. This high amount of debt coming due in the short term includes the first series of the private debentures (BRL831 million), and is due during October. The company counts on additional liquidity coming from two stand-by credit facilities that have undrawn resources of BRL970 million.
Fitch expects Hypermarcas to execute the call option on its 2021 bond during April 2016. The company has USD323 million of outstanding balance on the USD750 million bond and should fund this repurchase through local banking debt. The company has the strategy to reduce its currency mismatch risk, as about 100% of its revenues are generated domestically. To mitigate FX exposure, the company operates with hedge instruments for its debt-service payments in the next 12 months and for total debt principal and suppliers.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
--Long-term foreign currency Issuer Default Rating (IDR) at 'BB+';
--Long-term local currency IDR at 'BB+';
--Senior unsecured notes due in 2021 at 'BB+';
--Long-term National Scale rating at 'AA(bra)';
--Third debentures issuance at 'AA(bra)';
The Rating Outlook remains Positive.
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