TEXT-Fitch affirms OAO Synergy at 'B'; stable outlook

Wed Oct 31, 2012 8:24am EDT

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(The following statement was released by the rating agency)

Oct 31 - Fitch Ratings has affirmed OAO Synergy's (Synergy) Long-term foreign and local currency Issuer Default Ratings (IDR) at 'B'. The agency has also affirmed Synergy's senior unsecured rating at 'B'/'RR4' and its National Long-term Rating at 'BBB+(rus)'. The Outlook on the IDRs and National Rating is Stable.

The affirmation reflects Synergy's number-one market position in the Russian spirits market achieved during 2012 thanks to its effective distribution network, well recognised brands and a diversified portfolio by pricing points. These aspects have turned Synergy into one of the leaders in the industry. However, this is contrasted with a likely increase in leverage as a result of Fitch's expectation of weak profitability due to heavy marketing investments in the short term and the ongoing increases in excise duties applied to vodka in Russia.

Synergy managed its balance sheet conservatively during 2010 and 2011, with net FFO leverage of around 1.5x. Fitch expects leverage to increase by FYE12 towards 2.5x-2.8x and probably remain high during 2013. The increase will be driven by the continuing absorptions from working capital outflows - especially as the industry stocks up ahead of the sharp excise duty increase coming into force from January 2013 -and further investments in the food unit, in addition to share buybacks conducted during the year.

Fitch considers leverage of 3.0x high and at the top end of the band compatible with the company's current 'B' IDR. However, the agency takes some comfort from the fact that the company holds treasury shares currently worth over RUB2.5bn (equal to 0.8x annual EBITDA), which can be monetised when their valuation improves.

In 2013, Fitch expects the planned duty increases to accelerate the pace of decline for consumption of vodka in Russia and to especially affect demand in the duty-paying portion of the market, as well as to constrain Synergy's ability to raise prices for its products sold in the low-middle, middle and lower tier of the sub-premium pricing point segments of the Russian vodka market. Fitch estimates that Synergy's exposure to these segments accounts for approximately half of the company's bottled spirits volumes.

Additionally, the agency notes that further excise duty increases are planned for 2014. While Synergy's sales volumes could remain partly insulated by the compounded adverse effect of these increases that commenced in 2012, its resilience will be dependent on the severity with which the authorities are able to minimise a migration of consumption to cheaper non-duty paying products.

In assessing the above risks and challenges on Synergy's credit profile, Fitch also takes comfort from the company's stronger control of its distribution network and its ability to tactically reduce A&P expenses from 2013 onwards when it will no longer be allowed to advertise alcoholic beverages in Russia.

In its stress projections, Fitch also analysed a scenario with a 10% decline in volumes and no price increases in 2013, followed by a further volume decline and very limited price increases in 2014. The agency concluded that despite a likely profits drop and spike in leverage towards 3.0x in 2013, the company's leverage should return comfortably below 3.0x by FY14.

WHAT COULD TRIGGER A RATING ACTION?

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:

- Deterioration of net lease adjusted FFO leverage above 3.0x

- Persistently negative FCF from high investments in working capital or capex, or aggressive acquisitive activity, if not mitigated by asset disposal or equity injections

- More adverse than unanticipated regulatory changes in Russian spirits sector that will be difficult to offset by stronger market position

Positive: Subject to the absence of liquidity concerns and to maintaining well spread out maturities covered by available committed lines, as well as evidence of resilience to the ongoing excise duty increases, future developments that may, individually or collectively, lead to a positive rating action include:

- FCF turning and remaining positive, with EBITDA margin maintained above 13%.

- Net lease adjusted debt / FFO below 1.5x on a sustained basis

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