Fitch Downgrades Entel to 'BBB'; Outlook Negative
The ratings downgrade reflects Entel's continued negative free cash flow (FCF) generation and deterioration in its financial leverage during 2015, mainly driven by its aggressive marketing and network investments in Peru. The Negative Outlook reflects Fitch's view that the trend is unlikely to reverse in the short to medium term as Entel would remain focused on improving its market position in Peru, where the underlying industry growth potential is higher than the more mature Chilean market. As such, considering the company's intense marketing campaign, Fitch does not forecast the company to reach an EBITDA breakeven point in Peru until the fourth quarter of 2017, which is worse than Fitch's previous expectation.
ENTEL's ratings also reflect its leading market position in the Chilean mobile telecommunications industry, fully integrated service portfolio, strong brand recognition, as well as the moderate regulatory risk in Chile and Peru. Conversely, the ratings are tempered by increasing industry maturity in Chile, the company's aggressive growth strategy in Peru, and increased leverage compared to its historical level.
KEY RATING DRIVERS
Leverage Deterioration:
Entel's ongoing leverage deterioration is likely to continue in 2016 due to continued negative FCF generation driven by high capex for growth, mainly in Peru. The company's total debt continued to rise at a steep pace to CLP1.407 billion at end-2015 from just CLP840 billion at end-2013, resulting in its net leverage increasing to 3.6x from 1.8x during the same period. Including the off-balance sheet debt adjustment for rental expenses, the adjusted net leverage ratio was 4.0x at end-2015, which is deemed high for the rating category.
Fitch does not believe the company would be able to curb the negative FCF generation in 2016 and 2017 given its growth strategy and high capex needs under the competitive operating environment in both Chile and Peru. As a result, Fitch forecasts the company's adjusted net leverage to further increase to 4.9x in 2016 (net debt/EBITDA of 4.4x), despite no dividend payments due to its net losses incurred in 2015. Fitch expects the ratio to gradually fall to below 4.0x (3.0x of net debt /EBITDA) over the medium term as EBITDA loss in Peru narrows.
Weaker-than-expected Performance in Peru:
Entel Peru is projected to continue its negative EBITDA until 2017, which is worse than Fitch's previous forecast, due to its high subscriber acquisition costs, mainly handset subsidies. While the company's market share growth strategy in Peru has made good progress, with its sales increasing by 56% to USD346 million in 2015, with a 80% growth in its subscriber base, its EBITDA remained negative at USD238 million during the period. Capex requirement will remain high at USD485 million in 2016, including the planned USD285 million for the 700 Mhz auction, and USD185 million 2017. As such, negative FCF will remain uncurbed over the medium term.
Positively, the ongoing geographical diversification of the company's cash generation should benefit its credit profile over the long term. Entel Peru is the third player in the Peruvian mobile market, with a 10% market share at the end of 2015. With its strong 4G service promotion, the company increased its subscriber base by 80% to 3.1 million during 2015, of which 45% were postpaid. Entel Peru also complements ENTEL's existing fixed-line operation in Peru, through its other subsidiary, Americatel Peru, and it should be able to provide a convergent service for its corporate clients. Americatel generated USD37 million in revenues in its IT services business and USD27 million of revenues in the call center business in 2015.
Potential Capital Increase:
Entel plans a capital increase of USD500 million (CLP350Bn) in order to finance its investment plan in Chile and especially in Peru (including 700 Mhz Spectrum acquisition). This capital increase will be decided by the extraordinary stakeholder meeting to be held in April. The potential capital increase should help improve the financial flexibility and leverage ratio of the company. With this capital injection, Fitch forecasts the company's adjusted net leverage to decline to 3.5x by end-2017.
Negatively, should all of the proposed capital injection be funded with debt at the parent company level, the increased needs for dividend payments from Entel to support its parent company's debt service will place a burden on Entel's cash flow generation over the long term, further pressuring the company's ratings.
Stable Operations in Chile:
Despite the reduction of 75% of access charges in 2014 and 15% in 2015, the company was able to maintain the operational performance in Chile, its core operation, with focus in a high value postpaid clients in a market with high competitive environment. This reduction of access charges explain the low growth of 1% in Mobile service revenue associated with a reduction of 3% in a client base (drop of 4.6% in a prepaid client base). This reduction of prepaid client base was due to the reduction in the value of this portfolio after the change in termination rates. This was partially offset by the growth of 1% in a postpaid client base, and the growth of 4% in the corporate and SME segment. In terms of EBITDA, the reduction of access charges implied a reduction of 1% in EBITDA margin.
Equity Rating:
The equity rating of Entel is based in the strong credit profile of the company, its long track record in the stock market, a 45.2% of free float and a market presence of 100%. Also, it considers the market capitalization of USD2 billion, one of the largest market capitalizations in the Santiago's stock market, and the high level of the daily trading volume that reached USD2 million on average in the last year (based on March 2016 information).
KEY ASSUMPTIONS
-- Chilean operation revenues to grow by low-single-digits in 2016 and 2017; EBITDA margin to remain stable;
-- Peruvian operation's annual EBITDA generation to remain negative until 2016 and 2017 (USD190 million and USD65 million, respectively); EBITDA margin in 2018 expected to be about 7%;
-- No dividends in 2016, due to net losses in 2015;
-- Capex-to-sales ratio to gradually fall from 29% in 2015 to 22%-20% in 2016 and 2017;
-- FCF generation to remain negative until 2018;
-- Net adjusted debt-to-EBITDAR leverage to peak at 4.9x (net debt to EBITDA of 4.4x in 2016) and fall gradually to 4.1x in 2017 (net debt/EBITDA 3.6x) and 3.5x in 2018 (net debt to EBITDA of 3.0x). This ratio for 2016 considers funds from investment of 700 Mhz auction in Peru come entirely from financial debt.
RATING SENSITIVITIES
Further negative rating action will hinge largely on the turnaround of its Peruvian operation. Fitch acknowledges that Entel's leverage should peak in 2016. A higher-than-expected capex and/or higher marketing expense or the absences of capital increase used to finance the investment plan (including USD285 million in auction of 700 Mhz spectrum), resulting in its net leverage remaining over 3.5x by the end of 2016 could result in a ratings downgrade.
Conversely, Fitch does not foresee a positive rating action in the short to medium term given the ongoing financial profile deterioration trend.
LIQUIDITY
Entel's liquidity profile is adequate as the company's readily-available-cash balance of CLP136 billon (USD192 million) fully covered its short-term debt obligation of CLP19.3 billion at end-2015. In addition, Entel has an extended debt maturities profile as its next sizable debt maturity of USD150 million is due only in 2019 and 2020, following its refinancing of debt maturities in 2015 and 2016.
FULL LIST OF RATING ACTIONS
-- Foreign and local currency Long Term IDRs downgrade to 'BBB' from 'BBB+';
-- USD800 million senior unsecured notes due in 2026, downgraded to 'BBB' from 'BBB+'.
-- National Scale long-term ratings affirmed at 'AA-(cl)';
-- Debt issuance programs #674 (Series K and L, registered but not issued) and #675 (Series M) affirmed at 'AA-(cl)';
-- Commercial paper affirmed at 'AA-(cl)/N1+(cl)';
-- National Equity Rating affirmed at 'First Class, Level 1'.
The Rating Outlook remains Negative.
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