Fitch Affirms Localiza's IDR at 'BBB'; Outlook Negative
Fitch Ratings has affirmed Localiza Rent a Car S.A. 's (Localiza) ratings as follows:
--Foreign currency (FC) Issuer Default Rating (IDR) at 'BBB';
--Local currency IDR at 'BBB'
--Long-term National Scale Rating at 'AAA(bra)';
--Unsecured sixth, seventh, ninth debenture issuance at 'AAA(bra)'.
The Rating Outlook for Localiza's FC IDR is Negative due to the 'BBB' Country Ceiling of Brazil, which constrains this rating, and the Negative Outlook of the sovereign's FC IDR. The Outlooks for Localiza's Local Currency IDR and its National Scale Rating are Stable.
Localiza's 'BBB' ratings reflect its dominant business position within the car and fleet rental industry in Brazil, its strong operational efficiency, robust liquidity, and continued commitment to a conservative capital structure. Fitch expects only a slight deterioration in Localiza's credit metrics for 2015 and 2016 due to the recession, as the company's business model has allowed it adjust to economic cycles. Localiza's sizable pool of unencumbered fleet vehicles is considered a source of liquidity and further bolsters its financial flexibility.
KEY RATING DRIVERS
Competitive Advantages Support Strong Business Profile
Localiza has a very strong competitive position in the Brazilian market. The company's leadership gives it a strong negotiating power with the automobile manufacturers and enables it to efficiently dilute fixed costs while maintaining adequate operating margins. Localiza's prominent used car sales distribution channel further supports its competitive advantages and enhances its financial flexibility. The company has a low cost of financing and strong access to credit markets, which further improves its competitiveness.
Profitability and Operating Cash Flow Under Pressure
Fierce competition and inflation costs have pressured Localiza's profitability, while higher interest expenses have weakened operating cash flow. Localiza has just launched a new yield management system that together with new cost reduction initiatives are expected to partially offset margin deterioration during 2016. Going forward, Localiza's solid business expertise and conservative approach in its pricing strategy will be key to avoiding further deterioration in its profitability on a potential further deceleration in the used car market. Localiza's performance is closely connected to its pricing strategy for selling used vehicles.
The tough macro scenario and more aggressive pricing strategy of some competitors have limited Localiza's ability to grow. During the LTM ended Sept. 30, 2015, net revenues grew 4% from 2014, reaching BRL4 billion, while operating fleet growth was 2.8%. In the same period, EBITDAR and funds from operations (FFO) were almost stable at BRL1.1 billion and BRL2.5 billion, respectively. During 2013, these figures were BRL1 billion and BRL2.3 billion. Increased labor costs and store rentals have been pressuring Localiza's profitability, limiting scale gains. During LTM Sept. 30 2015, Localiza's EBITDAR margin declined to 27.2%, which compares unfavorably with the historical range of 29% and 31%. Going forward Fitch foresees EBITDAR margins ranging from 26%-29%.
Weaker Free Cash Flow (FCF) Generation; Financial Flexibility Persist
The car and fleet rental industry demands significant investments in fleet renewal to support business growth. The company has successfully developed an asset sales strategy that allows it to sell around 70,000 used vehicles per year. This has enabled Localiza to sell vehicles consistently, including during the negative cycles of the industry and difficult economic environment. While light vehicle sales in Brazil dropped 34% through the first 10 months of 2015, Localiza's sales declined 5.6% in the period, but average prices were up 11%. Its strategy to operate with a very young fleet allows it to postpone fleet renewal and its strong sales channel helps to avoid further depreciation in selling prices. The proceeds from car sales have largely funded fleet renewal, given the significant discounts obtained from auto manufacturers for new vehicles. During LTM Sept. 30, 2015, capex for fleet renewal totaled BRL20 billion, and capex for growth, net of used car sales, reached BRL53 million. Helping to offset these disbursements, proceeds from used car sales totaled BRL1.8 billion.
During LTM Sept. 30, 2015, Localiza reported negative FCF of BRL76 million, after BRL2.4 billion of capital expenditures and dividends of BRL126 million. During difficult scenarios for the industry, Localiza has had the flexibility to improve its FCF generation by lowering its capex expenditures, as most of its capital investments are geared toward increasing the size of its fleet. Excluding capex related to expansion, Localiza generated BRL13 million of negative FCF during LTM Sept. 30, 2015, an increase from BRL113.7 million in 2014, but still a deterioration from the BRL276 million average from 2010-2013, per Fitch`s calculations. Fitch forecast Localiza's FCF to remain slightly negative during 2015 and 2016, in the range of BRL20 million to BRL60 million.
Strong Credit Metrics
Localiza has a track record of strong credit protection measures for the industry. From 2011 through the LTM ended Sept. 30, 2015, Localiza's FFO Adjusted Leverage averaged 1.4x, while the averages for its net adjusted debt/EBITDAR ratio was 2.3x. Fitch expects Localiza to keep FFO Adjusted Leverage at around 1.5x in the long term. For 2015 and 2016, Fitch's forecast is for FFO Adjusted Leverage of 1.5x and 1.7x, and then a decline to 1.5x through 2018 based on the recovery of operating margins. The potential market value of Localiza's relatively modern vehicle fleet is about 1.7x the value of its net debt. Localiza could monetize these assets in the event of a cash flow crisis, since they are not linked to guarantees.
-- Low-single-digit decline in total operating fleet in 2016 with marginal improvement in 2017;
-- Softer EBITDAR margins in the 26%-29% range;
-- FCF neutral-to-slightly negative (lower by BRL60 million);
-- Cash balance remains sound compared to short-term debt;
-- Dividends at 25% of net income;
Negative: Future developments that may, individually or collectively, lead to a negative rating action:
-- Change in management commitment to a strong liquidity position;
-- Deterioration in leverage ratio, measured by FFO Adjusted Leverage, to more than 1.8x on sustained basis;
-- EBITDA margins declining below 22% on a sustained basis;
-- Deterioration of the coverage ratio fleet value to net value to below 1.5x;
Also, 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 and debt ratings. Conversely, positive rating actions are limited by Brazil's country ceiling of 'BBB' and the industry's inherent risk profile.
Localiza's management has adopted a conservative and proactive financial strategy to limit the risks associated with its exposure to the cyclical and capital intensive nature of its business. On Sept. 30, 2015, the company had total adjusted debt of BRL3.4 billion and cash of BRL1.3 billion. Localiza shows a quite strong debt amortization schedule, with cash sufficient to cover all debt coming due until mid-2018. Localiza's sizable pool of unencumbered fleet is also considered a source of liquidity. As of Sept. 30 2015, the company reported a fleet market value of approximately BRL3.3 billion, which corresponded to net debt coverage of 1.7x.
Date of Relevant Rating Committee: Nov. 18, 2015]
Additional information is available on www.fitchratings.com.
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