January 5, 2018 / 2:11 PM / a year ago

Fitch Rates Rede D'Or's Senior Unsecured Notes 'BB+(EXP)'

(The following statement was released by the rating agency) CHICAGO, January 05 (Fitch) Fitch Ratings has assigned a 'BB+(EXP)' rating to the proposed senior unsecured bonds up to BRL500 million due in 7 or 10 years to be issued by Rede D'Or Finance S.a. r.l., which is a wholly owned subsidiary of Rede D'Or Sao Luiz S.A. (Rede D'Or) and is incorporated in the Grand Duchy of Luxembourg. The notes will be unconditionally and irrevocably guaranteed by Rede D'Or and will rank pari passu with its existing unsecured debt. The issuance's net proceeds will be used for general corporate purposes, including the repayment of indebtedness, capital expenditures and/or to increase liquidity. Fitch currently rates Rede D'Or's Long-Term Foreign Currency Issuer Default Rating (IDR) 'BB+'/Negative, and LT Local Currency IDR 'BBB-'/Stable. A full list of ratings follows at the end of this release. Rede D'Or's ratings reflect its strong competitive position in the fragmented hospital industry in Brazil, its prominent business scale, modest leverage, strong liquidity and the defensive nature of its business fundamentals across economic cycles. The company's recent operating performance has proven resilience to the economic downturn. The increasing imbalance between available supply of hospitals and demand for these services is also a positive consideration, as is the ability of the company to pass along rising costs to its clients. Among the company's main challenges is its ability to efficiently manage working capital needs, since counterparties are facing more cash flow pressure. The company's strong business scale and bargaining power mitigate some of this risk. The need for constant investment in technology and equipment renewal, as well as potential regulatory issues, are seen as manageable risks Fitch expects Rede D'Or to continue to cautiously manage its strong business growth (organic and inorganic) and dividends distribution in a manner that results in solid leverage metrics. Fitch's base case scenario forecasts around BRL1billion-BRL1.5 billion in acquisitions during the next three years, and net adjusted leverage ratios of slightly above 2.0x. The ratings also reflect Fitch's expectation that Rede D'Or will remain disciplined in maintainlng a robust liquidity position as part of its proactive liability management strategy to mitigate refinancing risks. The Rating Outlook for the Foreign Currency rating remains Negative and mirrors Fitch's Negative Outlook for the Brazilian sovereign (FC IDR BB). Rede D'Or's FC IDR is capped by Brazil's Country Ceiling of 'BB+', as it operates only in Brazil. KEY RATING DRIVERS Leading Business Position: Rede D'Or is the largest private hospital networks in Brazil's fragmented and underdeveloped hospital industry. The company owns 35 hospitals, manages one and has three under construction. The company has solid business positions and large scale operations in its key markets: Rio de Janeiro, Sao Paulo, Brasilia and Recife. Business scale is a key issue in this industry and supports Rede D'Or's ratings, as it allows for lower fixed-costs and provides significant bargaining power with counterparties and the medical community in general. Geographic Concentration: Geographic concentration in the states of Rio de Janeiro and Sao Paulo is partially mitigated by robust economic activity in these regions compared with other parts of Brazil, as well as the strength of the health insurance companies. Since early 2015, there is a new regulatory framework for the Brazilian hospital industry that allows foreign-interest ownership, which could increase competition in the long term. Nevertheless, Rede D'Or's strong brand and large business scale in the cities in which it operates are competitive advantages, and it will be difficult for new entrants to replicate its position in the medium term in these key markets. Focused on Growth: Rede D'Or is expected to continue to pursue both organic and inorganic growth. The company has an aggressive track record of acquisitions. From 2010 to September 2017, Rede D'Or acquired 21 hospitals, adding 2,900 operating beds. Since 2015, Rede D'Or has had two new shareholders, HPT Participacoes SA (Carlyle Group), which provided a capital injection of BRL1.8 billion, and Pacific RDSL Participacoes (GIC Group). Solid Profitability: Rede D'Or has been efficient in increasing profitability through economies of scale and achieving synergies from its acquisitions. The company's net revenue grew 118% between 2013 and the LTM period ended Sept. 30, 2017, while average operating beds expanded by 44% to 5,200. During this period, the company's occupancy rate ranged from 77% to 81%, while its EBITDAR margin expanded to 27% from 19%. Rede D'Or's operating margin is among the highest of its hospital peers globally. Negative FCF: Rede D'Or's challenge is to effectively increase its FCF, which compares poorly to other investment-grade peers. Nevertheless, Fitch believes the company has flexibility to reduce dividends or to carefully manage acquisitions in order not to jeopardize its credit metrics. Per Fitch's calculations, the company's pro forma EBITDAR substantially increased to BRL2.7 billion in the LTM 2017 from BRL777 million in 2013. While its funds from operations (FFO) were BRL1.6 billion during the LTM, its CFFO was only BRL634 million due to high working capital requirements, which is a business characteristics. FCF generation has been historically negative, averaging negative BRL410 million between 2013 and 2016. During the LTM, FCF was negative BRL1.1 billion, pressured by BRL979 million of dividend distributions. Under Fitch's base case scenario, Rede D'Or's CFFO, EBITDAR and FCF for 2017 are expected to be approximately BRL600 million, BRL2.8 billion and negative BRL1.1 billion, respectively. Modest Leverage: The mix of equity and profitability gains has been supporting Rede D'Or's deleveraging process. Until 2014, most of Rede D'Or's growth was financed through debt. The company's FFO adjusted leverage reached 3.4x as of the LTM, while its net adjusted debt/EBITDAR ratio was 2.4x for the same period. These ratios compare with averages of 4.2x and 3.8x, respectively, between 2012 and 2015. Fitch's base case scenario considers the company continuing to benefit from improvements in operating cash flow generation and being able to maintain net adjusted leverage ratios of around 2.2x over the next three years. DERIVATION SUMMARY Rede D'Or has a relatively better business risk profile than its peer in the Brazilian healthcare industry - Diagnostico da America S.A., rated 'AA+(bra)', due to the much lower competitive pressure it faces. In terms of business scale, they both have sound bargaining power with the healthcare providers and insurance companies in Brazil and a strong brand in the industry. Relevance of its business where it operates is a key competitive advantage when discussing payments and pricing with counterparties. Rede D'Or faces higher technological risk but Fitch considers it to be manageable at this time. Both companies are showing an aggressive growth strategy. From a financial risk perspective, Rede D'Or shows lower leverage and greater financial flexibility, considering its ability to manage FCF generation, reducing growth or dividends distribution. On a global basis, the dynamics of the hospital industry in Brazil as well as the regulatory model are quite different compared to those in others countries, which means such a comparison is not really appropriate. On a financial basis, Rede D'or's operating margins and financial metrics look quite sound compared to others rated hospitals within Fitch's global universe. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: --BRL1.4 billion in acquisitions up to 2019; --EBITDAR margins of around 28%; --Continued high working capital needs, pressuring CFFO; --Capex of BRL800 million in 2017 and an average BRL1.3 billion to 2019; --Dividends of 25% of net income. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action: Because of Rede D'Or's strong growth strategy, which has pressured FCF, Fitch does not expect a positive rating action in the medium term. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action: --EBITDAR margins declining to below 24%; --Deterioration of sound liquidity position, with cash/short-term debt ratio below 1.0x on consistent basis, leading to refinancing risk exposure; --Net adjusted leverage consistently above 2.7x; --A change in management's strategy with regard to its conservative capital structure could also lead to a downgrade, as could deterioration in the company's reputation and market position. LIQUIDITY Robust Liquidity: Rede D'Or has a track record of keeping strong cash balances, with an average coverage of cash/short-term debt of 2.3x during the last three years. As of Sept. 30, 2017, the company had BRL6.9 billion of debt, of which BRL679 million is due in the short term. In Fitch's view, Rede D'Or's cash on hand (BRL2.9 billion) is sufficient to support debt amortization until to mid-2020. Fitch expects that Rede D'Or will remain disciplined as to its liquidity position and will maintain its proactive approach in liability management to avoid exposure to refinancing risks. FULL LIST OF RATING ACTIONS Fitch has assigned the following expected rating: Rede D'Or Finance S.a. r.l. --Senior unsecured notes 'BB+(EXP)' due in 7 or 10 years. Fitch currently rates Rede D'Or as follows: --Long-Term Foreign Currency IDR at 'BB+'; --Long-Term Local Currency IDR at 'BBB-'; --National Long-Term rating at 'AAA(bra)'. The Rating Outlook is Stable. Rede D'Or's FC IDR is constrained by Brazil's 'BB+' Country Ceiling, and its Negative Outlook follows Fitch's Negative Outlook for Brazil's sovereign rating (FC IDR BB). Rede D'Or operates only in Brazil. The company does not have stand-by credit facilities abroad. Contact: Primary Analyst Debora Jalles Director +1-312-606-2338 Fitch Ratings, Inc. 70 W Madison Street Chicago, IL 60602 Secondary Analyst Renato Donatti Associate Director +55-11-4504-2215 Committee Chairperson Joe Bormann Managing Director +1-312-368-3349 Date of Relevant Rating Committee: Oct. 20, 2017 Summary of Financial Statement Adjustments --Total debt includes net derivatives and related parties; --Operating lease expenses pertaining to hospital real estate are capitalized using a multiple of 5x. Media Relations: Benjamin Rippey, New York, Tel: +1 646 582 4588, Email: benjamin.rippey@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. 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