OREANDA-NEWS. Business diversification away from the traditional advertising business has become a key rating factor for Mexican broadcasters against the backdrop of the subdued industry growth, according to Fitch Ratings. Despite weak advertising sales growth, Fitch believes that Grupo Televisa S.A.B.'s (Televisa; 'BBB+'/Outlook Stable) credit quality should remain intact mainly due to its robust growth of non-content operations, while any material recovery in TV Azteca S.A.B. de C.V.'s (TV Azteca; 'B+'/Outlook Negative) financial profile would prove challenging given its over-reliance on the domestic advertisement segment.

Weak advertisement demand under unfavorable macroeconomic conditions has caused contraction in traditional advertising sales for Mexican broadcasters during the first nine months of 2015 (9M15). During 9M15, domestic advertising revenues for Televisa and TV Azteca suffered 9% and 10% contractions, respectively, partly due to a lack of special event, such as World Cup in 2014. The operating margins related to these issuers' advertising segments have also declined, although the impact was marginal for Televisa as it has U.S. dollar denominated content sales. The entrance of Cadena Tres from 2016, the winner of the national broadcasting concession, does not bode well for the growth potential of the existing operators' advertisement business segments.

Positively for Televisa, this negative impact has been fully mitigated due to its well-diversified revenue sources. The robust growth momentum in its pay-TV and telecom operations remains unscathed, with a 27% growth in segment revenues during 9M15; the trend is likely to continue in the short to medium term given the company's continued high investment and still moderate penetration rates of those services. As of June 30, 2015, the penetration rates for broadband and pay-TV in Mexico were 43% and 54%, respectively.

Televisa also has a steady income stream from its content sales, including royalty from Univision, which mostly offset the negative advertising sales growth in its Content segment during 9M15. As the importance of advertising revenues gradually declines, which represented 24% of consolidated revenues during 9M15, Fitch does not foresee any material deterioration in the company's credit profile stemming from a weak advertising sector condition.

Meanwhile, TV Azteca's pure advertising-driven business model has faced a sharp erosion in its EBITDA generation; any meaningful contribution from its overseas telecom operations has yet to materialize. The company's revenue growth has remained broadly muted in the past several years due to its inability to effectively raise advertising prices given its weak market position, while production cost continued to rise pressuring its EBITDA margin to 11% during 9M15, which was a sharp drop from 24% during the same period a year ago and 29% in 2013. Given a rather marginal contribution from content sales and Azteca America operation, as well as Fitch's forecast for a continued EBITDA loss in Colombia at least until 2016, the company's cash flow generation will continue to be concentrated in the Mexican broadcasting sector, where the operating outlook remains tough.

TV Azteca's lack of cash flow diversification, which in turn has led to its failure to cope with the weak industry demand, amid continued negative free cash flow generation and high leverage, was among main factors in Fitch's recent downgrade of the company's ratings to 'B+' from 'BB-' on Nov. 5, 2015. As any material contribution from its non-advertising business would be unlikely at least over the medium term, the company's ability to quickly shore up its competitiveness in the main broadcasting operation will be crucial for its Rating Outlook. TV Azteca's successful execution of the turnaround initiatives, mainly price increases, and streamlined production cost structure amid a material reduction in capex, would be a key rating factor in 2016.