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Fitch Affirms United Confectioners at 'B'; Outlook Stable
October 10, 2017 / 3:15 PM / in 2 months

Fitch Affirms United Confectioners at 'B'; Outlook Stable

(The following statement was released by the rating agency) LONDON/MILAN/MOSCOW, October 10 (Fitch) Fitch Ratings has affirmed Russia-based JSC Holding Company United Confectioners' (UC) Long-Term Issuer Default Rating (IDR) at 'B'. The Outlook is Stable. A full list of rating actions is available at the end of this commentary. The rating is capped at 'B' by UC's weak corporate governance practices, while the company's strong business profile and moderate leverage are consistent with those of higher-rated peers. The Stable Outlook reflects our expectation that outflows to related parties will not increase and the company's funds from operations (FFO) adjusted leverage will remain below 4x over the medium term. This should enable UC to maintain adequate access to external liquidity to refinance its short-term debt. KEY RATING DRIVERS Leading Market Position: The ratings reflect UC's leading positions in the core confectionery market segments in Russia and its strong portfolio of nationally recognised brands. In 2014-2016 private labels gained market share amidst constrained consumer spending, but UC has been able to broadly maintain its market share in value terms. We believe that the company's focus on the medium-price segment and its increasing presence in the economy segment, together with high customer loyalty and a wide distribution network across the country, will enable it to retain its leading position in the Russian confectionery market over the medium term. Gradual Market Recovery: In 1H17 Russian confectionery sales volumes grew for the first time since 2014, signalling some recovery in consumer spending. We expect confectionery consumption to grow annually in the low single digits over the next three years, driven mostly by the economy segment and by bakery and sugary sweets. We do not expect significant shifts towards more expensive categories or price points due to the likely persistence of weak consumer sentiment. We project UC's sales volumes in 2017 will outperform the market and grow by around 5% (1H17: 6% on 1H16) as the company has introduced new brands and products in price segments or in categories that benefit from greater consumer demand. Drop in EBITDA: UC's EBITDA dropped to RUB4.8 billion in 2016 from RUB7.6 billion in 2015 due to higher raw-material costs and marketing expenses, with the latter incurred to withstand increased competition. We do not expect EBITDA to increase to pre-2016 levels but project some recovery over the medium term to RUB5.5-6.0 billion due to further growth in sales volumes and lower raw-material costs. Loose Corporate Governance Practices: Fitch views weak corporate governance as potentially affecting unsecured creditors. We therefore cap UC's rating at 'B', although the company's credit metrics and business profile are commensurate with a higher rating. Sizeable loans to related parties, a lack of management and board independence, and the portion of UC's cash held at the related Guta Bank are the major constraining factors for the rating. Manageable Related-Party Outflows: We assume that outflows to shareholders and related parties will remain at manageable levels over 2017-2020, allowing UC to maintain its moderate leverage and retain adequate access to bank financing. We understand from management that Guta Group remains committed to keeping a manageable debt burden at UC as it is its major cash-generating asset. According to management, UC's debt should fall to RUB10-11 billion by end 2017 due to significant planned cash repayment from related parties. However, in our rating case we conservatively factored in only RUB0.8 billion already received in September 2017, leading to a stable debt level of RUB14 billion at end-2017. Increased but Acceptable Leverage: We project FFO adjusted gross leverage will decrease to around 3.5x in 2017 after peaking at 3.8x in 2016. We expect deleveraging to be supported by a recovery in EBITDA and an inflow of cash from the repayment of related-party loans. We conservatively assume UC will resume related-party funding or investments in non-core assets from 2018, leading to higher FFO adjusted leverage of 3.8x over 2018-2020. Nevertheless, these leverage metrics are strong compared with those of similarly rated peers, and taking into account UC's weak corporate governance, are commensurate with the company's 'B' rating. DERIVATION SUMMARY UC is smaller than the leading Latin American confectionery producer Arcor S.A.I.C. (Local-Currency IDR of BB/ Stable) and less geographically diversified, but has similarly strong brands and credit metrics. UC has the same scale as, and shares the single-country asset concentration of the Turkish food and beverage producer Yasar Holding A.S. (B/Stable) but with lower exposure to FX risks and a more conservative capital structure. UC's rating is capped at 'B' due to exceptionally weak corporate governance practices. No parent/ subsidiary aspects or Country Ceiling constraint were in effect for this rating. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - 5% growth in sales volumes in 2017; 2% growth - from 2018; - selling price increases below food CPI; - EBITDA margin at around 8.5% over 2017-2020; - capex related to core business at around 3% of revenue over 2017-2020; - RUB0.8 billion inflows from related parties in 2017; - RUB1.6 billion payment in 2017 to repurchase non-controlling stake; - cash distributions (dividends, loans to related parties and investments in non-core assets to support the strategy of Guta Group) close to prior-year net profit over 2018-2020. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action An upgrade is unlikely unless there is consistent evidence of improved corporate governance practices Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Sustained material deterioration in free cash flow (FCF) generation, driven by operating underperformance - FFO-adjusted gross leverage sustainably above 4.0x - Larger-than-expected distributions to Guta Group or material investments in non-core assets not balanced by greater pre-dividend FCF - Deterioration in liquidity position or inability to refinance short-term debt LIQUIDITY Weak Liquidity: At end-June 2017 Fitch-adjusted unrestricted cash of RUB0.9 billion, available undrawn committed bank lines of RUB1.2 billion and expected positive FCF were not sufficient to cover short-term debt of RUB3.9 billion. However, the major portion of short-term debt (RUB2.5 billion) was related to short-term tranches under long-term RCF due in 2019, which we expect to be rolled over. Liquidity and refinancing risks may increase if there is larger-than-expected cash leakage to related parties. KEY RECOVERY RATING ASSUMPTIONS The recovery analysis assumes that JSC Holding Company United Confectioners would be considered a going-concern in bankruptcy and that the company would be reorganised rather than liquidated. We have assumed a 10% administrative claim. UC's going concern EBITDA is based on 2016 EBITDA. The going-concern EBITDA estimate reflects Fitch's view of a sustainable, post-reorganisation EBITDA level upon which we base the valuation of the company. The going-concern EBITDA is 10% below 2016 EBITDA to reflect the company's exposure to imported raw materials and volatility in cocoa, sugar and milk prices. We have decreased the EBITDA discount to 10% from 40% as we believe that EBITDA was unsustainably low in 2016 and already included commodity price shocks. An EV multiple of 5x is used to calculate a post-reorganisation valuation and reflects a mid-cycle multiple. It is in line with multiples we use for Russian companies in retail and packaged food/ beverage sectors. Rouble bonds are issued by the finance company OOO United Confectioners-Finance, but Fitch treats them pari passu with senior unsecured debt of operating companies due to public offers (akin to guarantees) from three major production plants. The waterfall results in a 100% recovery corresponding to 'RR1' recovery for the senior unsecured rouble bonds (RUB1.2 billion outstanding external obligation at end-June 2017). However, the Recovery Rating is capped at 'RR4' due to the company's Russian jurisdiction. Therefore, the senior unsecured bonds are rated 'B'/50%/'RR4'. FULL LIST OF RATING ACTIONS JSC Holding Company United Confectioners -- Long-Term IDR: affirmed at 'B'; Outlook Stable OOO United Confectioners-Finance -- Senior unsecured rating: affirmed at 'B'/'RR4' Contact: Principal Analyst Anna Zhdanova, CFA Associate Director +7 495 956 2403 Supervisory Analyst Giulio Lombardi Senior Director + 39 02 8790 87214 Fitch Italia S.p.A. Via Morigi 6 20123 Milan Committee Chairperson Maxim Edelson Senior Director +7 495 956 9986 Summary of Financial Statement Adjustments Cash: Fitch adjusted available cash at end-2016 by deducting RUB325 million for cash held at related-party bank. Operating Leases: Fitch has adjusted the debt by adding 6x annual operating lease expense (2016: RUB178 million). The 6x lease multiple is standard for companies operating in Russia. Media Relations: Julia Belskaya von Tell, Moscow, Tel: +7 495 956 9908, Email: julia.belskayavontell@fitchratings.com; Adrian Simpson, London, Tel: +44 203 530 1010, Email: adrian.simpson@fitchratings.com. Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. Applicable Criteria Corporate Rating Criteria (pub. 07 Aug 2017) here Country-Specific Treatment of Recovery Ratings (pub. 18 Oct 2016) here Non-Financial Corporates Notching and Recovery Ratings Criteria (pub. 16 Jun 2017) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. 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