December 07, 2015 | Cbonds
Fitch Ratings has revised the Outlook on Russia-based vodka producer PAO Synergy's (Synergy) Long-term foreign and local currency Issuer Default Ratings (IDRs) to Negative from Stable and affirmed the IDRs at 'B+' and National Long-term rating at 'A-(rus). A full list of rating actions is below.
The Negative Outlook reflects our expectation that increased competition from lower priced illegal and regional vodka producers will persist in 2016, amid impaired consumer spending in Russia, affecting Synergy's vodka sales volumes and pricing power. The Outlook also captures diminished headroom under the 'B+' rating due to the company's stretched credit metrics in 2015 and deteriorated financial flexibility relative to our previous projections.
The ratings are underpinned by Synergy's strong position in the Russian alcoholic beverages market, which is supported by a portfolio of national and regional brands as well as a more developed distribution platform and larger scale of operations than most competitors. The affirmation reflects Fitch's expectation that the projected breach of downgrade sensitivity in 2015 is temporary and leverage should gradually return in line with the agency's guidance. The ratings are also supported by Synergy's limited FX risks and good liquidity position, backed by substantial undrawn committed credit lines.
KEY RATING DRIVERS
Increased Competitive Pressure
Synergy's trading in 9M15 was below Fitch's expectations due to strengthened competition from illegal vodka market players and regional producers, who benefited from consumers shifting to cheap vodkas priced at the minimum allowed level. We expect Synergy's sales volumes to remain under competitive pressure in 4Q15 and 2016 as we believe that the government's potential upping of momentum against illegal producers could take time to have favourable effects for legal producers like Synergy. As a result, we project Synergy's sales volumes to decrease by 7% and 3% in 2015 and 2016 respectively (9M15:-9%), while in 2017 additional pressure may come from the planned 5% excise duty increase.
After dropping by 25% in 2014, Fitch expects Synergy's EBITDA to decrease further by around 8% to RUB2.6bn in 2015 as a result of sustained high selling and marketing expenses and lower vodka sales volumes. Mitigating recent underperformance, Fitch expects cost-cutting initiatives, which the company has developed in response to shrinking profits, to start delivering benefits from 2016 and fully benefit the company's 2017 profitability. As a result, we project EBITDA should recover to around RUB3bn in 2016-2017.
Increased but Acceptable Leverage
We estimate that reduced profit generation in 2015, together with the acquisition of a minority stake in an alcohol retail chain in 1H15, will lead to funds from operations (FFO) adjusted leverage increasing to 4.3x in 2015. The metric will therefore temporarily exceed our downgrade trigger of 4x in 2015 but likely reduce to around 3.8x-3.9x over 2016-2018 thanks to EBITDA margin improvement, moderate capex spending and stable working capital turnover in the coming three years. We consider these levels acceptable for the rating and also derive comfort from the management's commitment to deleveraging with long-term net debt to EBITDA target of 2.5x (2014: 2.9x).
Stretched Financial Flexibility
Fitch considers Synergy's financial flexibility as limited due to weak FFO fixed charge coverage ratio (2014: 1.9x) and the company's constrained ability to protect cash flows through further capex reductions. We project FFO fixed charge cover to remain below the 'B' rating category median of 2.0x in 2015-2016 assuming the high interest rate environment in Russia will persist and no material changes in the fees that Synergy pays for bank guarantees needed to obtain excise stamps. At the same time, Synergy's limited FX risks and good liquidity position backed by substantial undrawn committed lines are positive for the credit profile.
Although still heavily exposed to the Russian vodka market, Synergy's product diversification has improved as its brandy and infusions production and imports of alcoholic beverages altogether accounted 29% of alcohol segment revenues in 2014 compared with 21% in 2013. We expect further product diversification to slow down, being only marginally supported by the expansion of own production of low-priced brown spirits, while sales growth of imported spirits may be constrained by weaker consumer sentiment in the country. These projections do not assume any new contracts for distribution of third-party brands.
Geographic diversification is growing slowly, with exports accounting for 7% of the alcohol segment revenue in 2014. We consider there to be limited scope for significant improvement over 2015-2016 due to weakened consumer sentiment in the CIS, Synergy's major export market.
Sales Mix Change Weigh on Margins
An increase in the contribution of imported spirits to total sales is diluting Synergy's EBITDA margin. While do not expect any recovery of margin to the mid-teen levels of 2011-2013, we view this strategy as beneficial in terms of enhancing the company's market position, top-line growth and business diversification. The strategy aims at leveraging Synergy's strong distribution platform and capturing opportunities provided by the evolution of consumer preferences in Russia towards a wider variety of products.
Structural Subordination Offset by Average Recovery Prospects
Fitch considers the RUB2bn rouble bond issued in June 2015 structurally subordinated to the rest of the group's debt as it is at the level of the holding company and not guaranteed by operating companies. However, average recoveries in case of default are supported by Fitch's going concern valuation approach, yielding better recoveries for unsecured creditors relative to the liquidation scenario alternative. As a result, the rating Fitch has assigned to this rouble bond is in line with Synergy's Long-term local currency IDR of 'B+'.
Fitch's key assumptions within the rating case for Synergy include
- Excise duties stable in 2016 and increasing to RUB523 per litre of ethanol in 2017; no increases thereafter, as per the Russian tax code.
- 7% drop in vodka sales volumes in 2015; 3% decrease p.a. in 2016-2017.
- Revenues from distribution of imported brands growing at mid-single digits from 2016.
- Net price increases below CPI.
- EBITDA margin contracting in 2015 and improving by around 0.5%-1.0% in 2016-2017 thanks to cost-cutting initiatives.
- Improvement in working capital turnover in 2015.
- No dividends or share buy-backs.
- Capex at around RUB600m per annum.
Negative: Future developments that could lead to negative rating action include:
- Deterioration of FFO-adjusted leverage sustainably above 4.0x and of FFO fixed charge coverage ratio below 1.5x.
- Persistently negative free cash flow (FCF) not mitigated by asset disposal or equity injections.
- Continued contraction of EBITDAR.
- Regulatory changes in the Russian spirits sector that may put more pressure on sales and profitability.
Positive: Future developments that could lead to a revision of the Outlook to Stable include:
- Evidence of an improving playing field in relation to illegally produced vodka in Russia, enabling Synergy's EBITDAR to resume growth.
- FCF generation not suffering from profit pressure or investments and moving into positive territory.
- FFO-adjusted leverage comfortably below 4.0x and FFO fixed charge coverage around 2.0x on a sustained basis.
- Maintenance of a strong liquidity buffer, in particular in relation to debt maturing in 2016 and 2017.
As at end-June 2015, Synergy had sufficient liquidity to cover its RUB1.5bn short-term maturities thanks to RUB7.0bn committed undrawn credit lines, while its unrestricted cash balances (RUB0.4bn) and FCF generation capacity remains limited. The company has a good track record of regularly renewing its credit lines and moderately diversified funding sources with proved access to the Russian debt capital markets.
Fitch also acknowledges the company's refinancing needs in relation to substantial debt maturities in 2016 and 2017.
FULL LIST OF RATING ACTIONS
Foreign currency Long-term IDR affirmed at 'B+'; Outlook revised to Negative from Stable
Local currency Long-term IDR affirmed at 'B+'; Outlook revised to Negative from Stable
National Long-term rating affirmed at 'A-(rus)'; Outlook revised to Negative from Stable
Local currency senior unsecured affirmed at 'B+'; Recovery Rating '4'
Company: Beluga Group
|Full company name||PJSC Beluga Group|
|Country of risk||Russia|
|Country of registration||Russia|