OREANDA-NEWS. January 19, 2016. Fitch Ratings has affirmed Ache Laboratorios Farmaceuticos S.A.'s ratings (Ache) as follows:

--Foreign Currency (FC) Issuer Default Rating (IDR) at 'BBB-'; Outlook Negative;
--Local currency IDR at 'BBB'; Outlook Stable;
--National scale rating at 'AAA(bra)'; Outlook Stable.

Ache's FC IDR is constrained by Brazil's 'BBB-' Country Ceiling, and its Negative Rating Outlook follows Fitch's Negative Outlook for Brazil sovereign (FC IDR 'BB+'). Ache's operations are predominantly in Brazil, with less than 5% of revenues coming from exports. The company does not have cross-border issuances.

RATING DRIVERS

Ache's ratings are supported by its strong business position in the Brazilian market and its leadership position in the prescription drug segment. The ratings also incorporate Ache's conservative financial strategy underpinned by an unleveraged capital structure and strong liquidity profile. The need for constant drug innovation and the regulatory burden of the sector are seen as manageable risks.

Fitch expects Ache to remain relatively unscathed by the recession in Brazil with only a marginal impact on its robust credit metrics. In the few years, EBITDA margins should decline to the 29%-31% range from the historical 32%-35%. The deterioration in operating margins is primarily due to inflationary costs pressures and USD appreciation. Despite this downward margin pressure, Fitch expects Ache's net leverage ratios to remain below 0.5x.

Solid Business Profile in a Competitive Environment

Ache has a solid and recognized brand in the Brazilian pharmaceutical industry. Its diversified product portfolio, leadership in the prescription drugs segment, and presence in the fast-growing over-the-counter (OTC), generics and dermo-cosmetics segments support its sound business profile. Ache is the third-largest laboratory in Brazil in terms of gross revenue and the second in net revenues. It also has one of the largest sales forces in the domestic market, which provides a key competitive advantage compared with peers. Ache's margins are solid and resilient, despite the challenging competition from large and well capitalized multinational pharmaceutical companies over the last years.

Similar to other emerging-markets pharmaceutical companies, Ache has a narrower research and development (R&D) product pipeline than its multinational competitors and has a weaker portfolio of patented products. Positively, the company's exposure to licensing agreements is low, representing less than 6% of revenues from these products. Ache has been constantly increasing its efforts to innovate and renovate its product portfolio by investing about 2.6% of its revenues in R&D. In the last 12 months ended September 2015, products launched rose to 27% of revenues from 22% in 2013 and 12% in 2012. Fitch expects Ache's new drug launches should result on average 25% revenue expansion from 2016-18.

Fitch expects Ache to move forward more actively to geographically diversify its operations through new partnerships and/or, to lesser extent, through small acquisitions. These acquisitions may also occur to further enhance its product portfolio or a specific niche in the near term. The agency considers that the company will remain cautious and maintain a conservative capital structure as it continues to grow.

Steady Cash Flow From Operations; Profitability Should Decline but Remain Sound
Ache has been efficient in balancing the expansion of generics with an innovative portfolio of branded products while achieving benefits from economies of scale. Fitch believes that Ache's operational expertise in Brazil in combination with its strong distribution system mitigate the threat of increasing competition. Its generic portfolio is not expected to account for more than 10%-15% of its revenues, according to Fitch's projections.

Ache has historically presented sound operational performance. During 2015, the combination of inflationary costs pressures and the BRL devaluation pressured profitability and EBITDA margins. Around 59% of Ache's COGS is linked to the U.S. dollar. Given the tough scenario in Brazil and a more efficient inventory management strategy of pharma wholesalers and retailers, Ache's ability to pass-through costs increases to prices is expected to be limited. Fitch forecasts Ache's EBTIDA margin moving around 29%-31%, a decline from the 32%-35% over the last four years.

For Sept. 30, 2015 (LTM), Ache's net revenue and EBITDA reached BRL2.3 billion and BRL683 million, respectively. These figures compare with net revenues of BRL2.1 billion and an EBITDA of BRL692 million in 2014. Funds from operations (FFO) and cash flow from operations (CFFO) remained quite robust, at BRL458 million and BRL429 million during the LTM, respectively.

Free Cash Flow Remain Pressured by Strong Dividends

Ache has a track record of maintaining an aggressive shareholder friendly policy, which has led to negative free cash flows (FCF) since 2012. Between 2012 and 2015, Ache generated an average negative FCF of BRL22 million. Dividend distributions averaged BRL441 million in the period. In the past three years, the company has increased its dividend payout in order to support the additional business opportunities of its controlling shareholders and due to the lack of attractive investments, paying out a total of BRL2 billion between 2011 and 2015.

This aggressive dividend policy has been underpinned by the company's strong CFFO and its unleveraged capital structure. Fitch expects that in a more challenging scenario, the company would pursue a more conservative dividend policy in order to increase its financial flexibility and sustain its strong capital structure. During the LTM Sept. 2015, Ache generated negative FCF of BRL175 million, due mainly to dividends distribution of BRL364 million.

Unleveraged Capital Structure
Ache has historically maintained low leverage ratios, and its credit measures continue to be quite strong. Fitch's projections indicate a net debt/EBITDA ratio below 0.5x in the next three years. In the past five years, the company's average leverage, as measured by the FFO to adjusted leverage ratio, was 0.6x, while its net debt/EBITDA ratio was negative.

Large Fiscal Contingencies, No Rating Impact Expected

Ache is engaged in approximately 61 legal proceedings for a total amount of BRL595 million. Out of this amount, BRL20 million is considered to be a 'Probable Loss' and the company has made provisions of BRL21 million. The balance of these litigations is split between the following classifications: BRL322 million as remote and BRL252 million as possible. Fitch believes it is extremely unlikely that these legal disputes will result in a negative rating action against the company. Litigation in Brazil tends to be prolonged, and unfavorable rulings tend to be paid over several years. If a payment of around BRL200 million were to occur, which Fitch would consider a worst case scenario, Ache's net leverage would still remain below 0.3x.

KEY ASSUMPTIONS

--Revenue growth in the low single digit range in 2016, with gradual recovery from 2017 on;
--Innovation to continue to represent around 25% of revenues (R&D expenses of around 3% Revenues);
--EBITDA margin in the range 29-31% due to inflation and the impact of the strong U.S. dollar on costs;
--BRL120 million of maintenance capex going forward;
--Maintenance of the high dividends payouts around 90% of Net Income;
--Disbursement of BRL 150 million in small acquisitions/partnerships in the next three years.

RATING SENSITIVITIES

Ache's credit ratios are very strong at the rating level. Nevertheless a further negative rating action on Brazil's sovereign ratings and country ceiling could result in negative rating action for the company's foreign currency IDR. Conversely, positive rating actions are limited by Brazil's country ceiling of 'BBB-'.

LIQUIDITY
Ache's has historically held a robust liquidity position. During the last 12 months (LTM) ended Sept. 30, 2015, Ache's cash balances plus CFFO covered its total debt by 2.8x. As of Sept. 30, 2015, the company had BRL210 million of cash and marketable securities and total adjusted debt of BRL228 million, of which BRL37 million was in the short term.