Overview -- We are assigning our 'B+' ratings to Peru-based fishing company Pesquera Exalmar and its proposed $200 million senior unsecured notes due 2023. -- The stable outlook reflects our expectation that the company's liquidity and credit measures will remain relatively stable during the next two years, despite its large capital expenditures for 2013 and the challenges associated with the start-up of its new business segment. Rating Action On Jan. 18, 2013, Standard & Poor's Ratings Services assigned its 'B+' long-term corporate credit rating to Pesquera Exalmar S.A.A. (Exalmar). At the same time, we assigned our 'B+' issue-level rating to Exalmar's proposed $200 million senior unsecured notes due 2023. The outlook is stable. Rationale The ratings on Exalmar reflect our assessment of the company's "weak" business risk profile, "aggressive" financial risk profile, "less-than-adequate" liquidity, and "fair" management. Our assessment of Exalmar's business risk profile as "weak" reflects the company's business concentration exclusively in the catch of anchoveta fish along the Peruvian coast. It also reflects the inherent volatility of the fishing industry, and exposure to adverse weather conditions, industry regulations, and global demand. The company is also exposed to international trade barriers from the countries to which it exports. The ratings also consider high working-capital requirements associated with the nature of Exalmar's business, which could result in sudden liquidity pressures, particularly during periods of limited cash availability. In addition, the volatility of international prices for Exalmar's core products hinders its ability to maintain a stable and predictable cash flow stream. The relatively small scale of Exalmar, as the fourth-largest fishmeal producer in Peru, also constrains the rating. Offsetting factors are the company's favorable geographic location, as Peru is the main producer of fishmeal and fish oil worldwide, with around 20% of world output. Additionally, favorable demand growth prospects for fishmeal and fish oil consumption, coupled with the company's gradual diversification into the direct human consumption (DHC) segment support the long-term sustainability of its business model. Moreover, Exalmar maintains a competitive cost structure thanks to its operating vertical integration, benefits from a positive and long-term track record in the fishing industry, and maintains sound and reliable relationships with third-party suppliers. Following the government's regulatory initiative to ensure the preservation of the anchoveta species, fishing companies in Peru have been operating under an individual transferrable quota (ITQ) since 2009. During the first half of 2012, Exalmar maintained a 6.45% quota in the North-Center region and 4.34% in the South region. Despite the volume catch limitations, the company has been able to successfully execute its growth strategy through M&A activity that has gradually increased its ITQ, third-party catch purchases to achieve economies of scale in its manufacturing facilities, and the recent diversification of the product portfolio into the DHC segment. The company's growth strategy, coupled with a favorable pricing environment in recent years, has resulted in EBITDA margins of about 30% during the last three years. In 2010, however, unfavorable weather conditions reduced Exalmar's fishmeal production volumes by 30%, resulting in an EBITDA margin of about 26%. We estimate Exalmar's operating efficiencies, such as gradual modernization of its fleet and increasing economies of scale, will maintain its EBITDA margins close to 30% in 2013. In our view, the favorable trend on fishmeal and fish oil prices should also help the company's profitability. We believe Exalmar's production efficiencies, coupled with the start-up of the DHC segment, would partly mitigate potential cash flow volatility associated with abrupt changes in the pricing environment. Our assessment of Exalmar's financial risk profile as "aggressive" reflects our expectation that leverage ratios will trend to the mid-2x area, the volatility in the quarterly results, and the company's focus on consolidating its operations and developing the DHC business segment, which should lessen cash flow volatility. In our base-case scenario, we assume: -- Fishmeal price increase during the second half of 2012, to around $1,700/ton because of lower volumes produced in Peru, but declining about 20% in 2013. -- Capital investments of $85 million in 2013 to continue supporting growth in the DHC segment. After 2013, the company should use most of its capital expenditures to support maintenance activities. -- Revenue growth of 26.4% in 2013 associated with the increase of ITQ, and more than 7% through 2016 due to the expansion of the DHC segment. We expect the company to continue seeking potential ITQ quota acquisitions in the Peruvian market, which would result in incremental debt. After 2013 we expect Exalmar to fund most of its growth with internal cash generation. We estimate annual cash flow from operations of about $50 million, which the company will use to support its investment needs, thus maintaining a capital structure consistent with its current financial profile. Our baseline forecast for 2013 assumes that Exalmar's total debt to EBITDA will be 3.0x, EBITDA interest coverage of 4.2x, and funds from operations (FFO) to total debt of 16.8%. Due to the seasonality of Exalmar's business, we factor in the rating the potential for high cash flow volatility, which requires its financial metrics to be stronger than those of companies with more stable cash flows. Liquidity Based on its likely sources and uses of cash during the next 12-18 months, our performance expectations, and pro forma for the transaction, Exalmar has "less-than-adequate" liquidity. Our assessment of Exalmar's liquidity considers the high working-capital requirements and the absence of committed lines of credit. Other relevant factors include the following: -- Sources of liquidity to exceed uses by at least 1.0x; -- Positive net sources; and -- Pro forma for the transaction, the company faces a smooth debt maturity profile for 2013-2016. As of Sept. 30, 2012, Exalmar's liquidity sources include a cash balance of approximately $28.9 million, and we estimate FFO of $47.2 million for 2013. Under our base-case scenario, we have incorporated capital expenditures of approximately $85.8 million in 2013, including the acquisition of small-size ITQ quotas. We also expect the company to use the proceeds to refinance existing debt and for general corporate purposes, including capital investments. We believe part of the capital expenditures for 2013 are discretionary, and expect management to reduce them if operating performance is below expectations, or if the company does not issue the proposed notes. We expect Exalmar to have working-capital needs at about $11.4 million in 2013, and we expect it to maintain cash balances above $10 million. The company has an outstanding syndicated bank loan that incorporates a 3.0x maximum consolidated leverage ratio and 1.25x debt service coverage ratio. We believe Exalmar maintains sufficient cushion to comply with its covenants. Outlook The stable outlook reflects our expectations that Exalmar's operating efficiencies will keep EBITDA margins at around 30%, despite potential volatility in the company's production volumes or abrupt changes in the pricing environment. We could downgrade Exalmar if weak operating results--due to adverse weather conditions or a significant drop in volume demand and prices---result in debt to EBITDA of more than 4x, or if cash flow pressures deplete its liquidity. In our view, the volatility of the fishing industry, combined with the company's limited scale and narrow geographic and product diversification, somewhat limits a positive rating action in the near term. Related Criteria And Research -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Key Credit Factors: Business And Financial Risks In The Branded Consumer Products Industry, Sept. 10, 2008 -- Standard & Poor's Revises its Approach To Rating Speculative-Grade Credits, May 13, 2008 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- 2008 Corporate Criteria: Ratios and Adjustments, April 15, 2008 Ratings List New Rating Pesquera Exalmar S.A.A. Corporate Credit Rating B+/Stable/-- Senior Unsecured B+ Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com.