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Fitch Downgrades Localiza's LC IDR to 'BBB-'; Affirms FC IDR at 'BB+' & National Scale at 'AAA(bra)'
November 17, 2017 / 9:17 PM / a month ago

Fitch Downgrades Localiza's LC IDR to 'BBB-'; Affirms FC IDR at 'BB+' & National Scale at 'AAA(bra)'

(The following statement was released by the rating agency) CHICAGO, November 17 (Fitch) Fitch Ratings has affirmed Localiza Rent a Car S.A.'s (Localiza) Long-Term Foreign Currency Issuer Default Rating (LT FC IDR) at 'BB+' and its National Scale rating at 'AAA(bra)'. At the same time, Fitch has downgraded Localiza's LT Local Currency IDR to 'BBB-' from 'BBB'. The Rating Outlook is Negative for the FC IDR and Stable for the Local Currency IDR and National Scale Rating. A full list of ratings follows at the end of this release. The downgrade of Localiza's LC IDR reflects the weakening of its credit risk profile due to a market-share oriented strategy, which has resulted in aggressive growth funded primarily through debt. This has resulted in relatively higher than expected leverage levels and recurring negative free cash flow generation. The demand in the car rental industry in Brazil has been growing despite the recession in the country and Localiza has been seeking to further enhance its position in this market. Localiza's investment grade ratings continue to reflect its prominent business position within the car and fleet rental industry in Brazil, strong operational efficiency, track record of solid financial profile (2017 leverage is at its historical peek), robust liquidity and well-spread debt amortization profile. Localiza's sizable pool of unencumbered fleet of vehicles bolsters its access to funding during difficult conditions, which is a key factor embedded in current ratings. Localiza's business model allows the company to adjust operations to economic cycles at its discretion, as seen in the past, which enhances financial flexibility. Negatively, competition has intensified, as its largest competitors have improved their financial profiles, while investing in growth. Fitch expects Localiza to remain committed to a sound credit risk profile. Sharp growth that remains debt financed could pressure its ratings. Fitch expects Localiza to keep FFO Adjusted Leverage and Net Adjusted Net Debt/ EBITDAR below 1.4x and 3.4x, respectively, in the long term. For 2017 and 2018, Fitch forecasts FFO Adjusted Leverage ratios of 1.7x and 1.4x and for 3.6x and 3.4x for the ratio Net Adjusted Net Debt/ EBITDAR. The Rating Outlook for the Foreign Currency rating is Negative and mirrors Fitch's Negative Outlook for the Brazilian sovereign (FC IDR 'BB'). Localiza's FC IDR is capped by Brazil's Country Ceiling ('BB+'). Localiza's operations are essentially in Brazil. The company does not have substantial assets or amount of cash held abroad. KEY RATING DRIVERS Strong Competitive Advantages: Besides its solid business expertise, Localiza has a prominent competitive position, underpinned by its larger scale, geographical distribution and a strong car sales distribution channel. Localiza had 171,876 vehicles as of Sept. 30 2017 and during the first nine months of 2017, the company sold 64, 451 vehicles. As it is in a capital-intensive industry, lower funding costs and strong access to credit markets are key competitive advantages. Localiza's integrated business model allows synergies and the flexibility to adjust operations amid demand volatility. Market-Share Strategy: Localiza's desire to grow its market-share and take opportunity to consolidate its business position has pressured its profitability over the last five years. More recently, the implementation of yield management platforms has allowed the company to increase utilization rates, which have been mitigated by tariff declines. During the LTM ended Sept. 30, 2017, consolidated rental revenues grew 14% from 2016, reaching BRL2.4 billion, while average operating fleet growth was 18%. In the same period, EBITDAR and funds from operations (FFO) grew to BRL1.2 billion and BRL3.7 billion from BRL1.1 billion and BRL2.8 billion, respectively. Localiza's EBITDAR margin declined to 22.4% during the LTM from 26.4% in 2016, and compares unfavorably with the historical average of 28%. Modern Fleet; Financial Flexibility: The car and fleet rental industry demands significant investments in fleet to support business growth. The company has successfully developed an asset sales strategy that allows it to sell around 100,000 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 increased 8% through the first nine months of 2017, Localiza's sales increased 36%; average prices were up 14%. Its strategy to operate with a modern fleet allows it to postpone fleet renewal, while its strong sales channel helps it to maximize sales prices. The proceeds from car sales have largely funded fleet renewal, given the significant discounts obtained from auto manufacturers for new vehicles. The significant increase in fleet this year will demand a further increase in vehicles sales during 2018, but Fitch considers that Localiza is relatively well positioned even though some price pressure could occur. Negative Free Cash Flow: During the LTM ended Sept. 30, 2017, capex for fleet renewal totaled BRL3.2 billion, and capex for growth reached BRL1.7 billion. Helping to offset these disbursements, proceeds from used car sales totaled BRL3.4 billion. Localiza reported negative FCF of BRL1 billion during this period after distributing dividends of BRL159 million. This negative FCF is far above the BRL484 million generated during 2016 and BRL278 million in 2015. 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. Nevertheless, during last few years Localiza's strategy has been to continue to grow and maintain its leadership position in the Brazilian market. Limited Recovery in Credit Metrics: The more aggressive growth, so far mostly debt financed, has been deteriorating Localiza's track record of strong credit protection measures. From 2012 through 2016, Localiza's FFO Adjusted Leverage averaged 1.2x, while its net adjusted debt/EBITDAR ratio averaged 2.1x. Fitch expects Localiza to keep FFO Adjusted Leverage and Net Adjusted Net Debt/ EBITDAR below 1.4x and 3.2x, respectively, in the long term. For 2017 and 2018, Fitch forecasts FFO Adjusted Leverage ratios of 1.7x and 1.4x and for 3.3x and 3.2x for the ratio Net Adjusted Net Debt/ EBITDAR. The potential market value of Localiza's relatively modern vehicle fleet is about 2.0x the value of its net debt. Localiza could monetize these assets in the event of a cash flow crisis, since they have not been used to secure the company's existing debt. DERIVATION SUMMARY Localiza's 'BBB-/AAA(bra)' ratings reflects its leadership position in the Brazilian fleet and car rental industry, that is more than two times larger than its closest competitors Movida Participacoes S.A (Movida/A+(bra)), Unidas S.A (Unidas/AA-(bra)) or Companhia de Locacao das Americas (Locamerica/AA-(bra). Localiza has a strong negotiating power with the automobile manufacturers, and its larger business scale enables it to efficiently dilute fixed costs while maintaining adequate operating margins. Localiza's prominet used car sales distribution channel and solid base of unencumbered assets further supports its competitive advantages and enhances its financial flexibility. Localiza's competitiveness is further strengthened by its low cost of financing and strong access to the local debt markets. Localiza is also quite well positioned in terms of leverage compared to the issuers above mentioned and when compared to JSL S.A (BB/AA-(bra)), the controlling shareholder of Movida. KEY ASSUMPTIONS --Increase of owned vehicles by 45,000 in 2017 and by 10,000 to 12,000 per year in 2018 and 2019; --EBITDAR margins in the 25%-26% range; --FCF negative by approximately BRL700 million in 2018; --Cash balance remains sound compared to short-term debt; --Dividends at 25% of net income. RATING SENSITIVITIES Negative: Future developments that may, individually or collectively, lead to a negative rating action: --Change in management commitment to a strong liquidity position; --Continued focus on market share at the expense of credit protection measures; --Aggressive competition that continues to lead to declining margins; --Deterioration in leverage ratio, measured by FFO Adjusted Leverage, to more than 1.5x on sustained basis; --Deterioration in leverage ratio, measured by FFO Adjusted Leverage, to more than 1.5x or Net Adjusted Debt/EBITDAR to above 3.5x on sustained basis. 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 for the FC IDR are limited by Brazil's country ceiling of 'BB+'. The inherit risk of the fleet and car rental industry and the current strong growth strategy of Localiza limit the upward rating potential of the company's BBB- LC IDR. LIQUIDITY 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. As a result, the company has a robust liquidity position and a well-spread debt amortization profile. Localiza has shown proven ability to access capital market, even during difficult credit market in Brazil during 2016 and early in 2017. On Sept. 30, 2017, the company had total adjusted debt of BRL5.9 billion, that includes BRL802 million of rental obligations, short-term debt of BRL553 million and cash of BRL1.9 billion. Localiza shows a quite strong debt amortization schedule, with cash sufficient to cover all debt coming due until mid-2020. Localiza's sizable pool of unencumbered fleet is also considered a source of liquidity. As of Sept. 30 2017, the company reported a fleet market value of approximately BRL6.6 billion, which corresponded to net debt coverage of 2.0x. FULL LIST OF RATING ACTIONS Fitch has taken the following rating actions: Localiza Rent a Car S.A. --Long-Term Foreign Currency (FC) Issuer Default Rating (IDR) affirmed at 'BB+'; Outlook Negative; --Long-term National Scale Rating affirmed at 'AAA(bra)'; Outlook Stable; --Unsecured sixth, seventh, ninth, 10th debenture issuance affirmed at 'AAA(bra)' --Long-Term Local currency IDR downgraded to 'BBB-' from 'BBB'; Outlook Stable; The Rating Outlook for the Foreign Currency rating remains Negative and mirrors Fitch's Negative Outlook for the Brazilian sovereign (FC IDR 'BB'). Localiza's FC IDR is capped by Brazil's Country Ceiling ('BB+'). Localiza's operations are essentially in Brazil. The company does not have assets or substantial amounts of cash held abroad. Contact: Primary Analyst Debora Jalles Director +1-312-606-2338 Fitch Ratings, Inc. 70 West Madison Street Chicago, IL 60602 Secondary Analyst Renato Donatti Associate Director +55-11-4504-2215 Committee Chairperson Joe Bormann, CFA Managing Director +1-312-368-3349 Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity are listed below: --Total debt includes net derivatives; --Capex was adjusted by acquisition of vehicles; --A multiple of 5 times was used to adjust operating leases. . Media Relations: Benjamin Rippey, New York, Tel: +1 646 582 4588, Email: benjamin.rippey@fitchratings.com. 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