RIO DE JANEIRO & CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the following ratings of Diagnosticos da America S.A. (DASA):
--Foreign and Local currency Issuer Default Rating (IDR) at 'BB+';
--Unsecured notes due 2018 at 'BB+';
--National Scale rating at 'AA(bra)';
--Local debentures due to 2016 at 'AA(bra)'.
In addition, Fitch affirms the following rating of DASA's subsidiary:
--DASA Finance Corporation's IDR at 'BB+'.
The corporate Rating Outlook is Stable.
KEY RATING DRIVERS
DASA's credit ratings reflect its leading position in the Brazilian medical diagnostics industry, strong and diversified portfolio of services and cash flow diversification from multiple counterparties, as well as favorable industry fundamentals. DASA's net adjusted debt-to LTM EBITDAR ratio of 3.1x as of June 30, 2013 is higher than Fitch's prior expectations, but is projected to decline to below 2.8x by 2013 and 2.5x in 2014.
Considerations that limit DASA's ratings at 'BB+' and 'AA(bra)' are ongoing challenges related to switching its business model from acquisition-driven to a model more focused on medical excellence and achieving efficiency from past acquisitions. DASA's ratings are also limited by the rapid consolidation of the diagnostic industry, which could increase competitive pressures in the near-term.
Strong Business Position
DASA is the largest company in the fragmented medical diagnostic industry, with an estimated market share of 12%. The company's size, reputation, multibrand portfolio, and broad geographic diversification are considered by Fitch to be competitive advantages that support the ratings. Besides the outpatient and inpatient services, which represent around 83% of the company's revenues, DASA also operates lab-to-lab services (10% of its revenues) and offers services to public entities. DASA's mix of services is distributed between clinical analysis and imaging tests (58%/42%). The company's strategy is to increase its share of imaging services in light of the high profitability of this segment; nevertheless, the largest market opportunities will continue to be in clinical analysis testing.
Fitch sees as credit positive the long-term focus of DASA's current shareholders, as well as its conservative track record in managing business in the healthcare industry. The company's management has passed through different phases over the last five years due to the influence of its main shareholder. At this stage, DASA's strategy is focused on long-term medical excellence and quality of service combined with adequate profitability. Fitch does not expect any relevant acquisition in the short term as DASA is focused on organic growth and the restructuring process, which should continue through mid-2014.
Change in Business Model; Impact on Margins and Market-Share
DASA has been facing some challenges while implementing several initiatives to improve customer service, medical excellence and efficiency. Over the last few quarters, DASA has shown lower growth rates than the industry and its main competitor. Operating margins have been pressured by the ramp-up of several new patient service centers (PSCs), integration costs, equipment replacements and call center changes. Positively, the company has shown some margin recovery in the 2Q'13. Inflation pressure should continue to challenge the company as it seeks to bolster margins in the upcoming quarters.
DASA generated BRL506 million of EBITDAR during 2012, a decline of 18.5% compared to 2011. EBITDAR margins were 22.3% during 2012, a decline of 6.2 basis points from 2011, reflecting the operational restructuring process and higher inflation costs, mostly related to medical fees and rents. For the LTM period ended June 30, 2013, DASA's EBITDAR was BRL499 million, while its margin was 16.3%. Fitch's base case indicates company EBITDA margins moving to the 18%-21% range from historical levels of 23%-25% due to stronger competition and higher operating costs.
Free Cash Flow Expected to Recover in 2014
As of June 30,2013, DASA generated funds from operations (FFO) of BRL252 million and cash flow from operations (CFFO) of BRL209 million. These figures compare to BRL214 million of FFO and BRL205 million of CFFO in 2012. After two years of negative free cash flow (FCF), the company returned to positive FCF for the LTM ended June 30, 2013 of BRL43 million. This level of FCF compares favorably with negative FCF of BRL40 million in 2012 and negative BRL229 million in 2011. FCF should be slightly negative in 2013, considering the ongoing capex program. In 2014, FCF should turn positive to range of between BRL50 million and BRL100 million.
Current Leverage Ratios Expected to Be at Peak
DASA's weaker operating cash flow generation, as measured by EBITDAR, over the last few quarters has led to an increase in leverage ratios. The company has a good track record of maintaining an adequate capital structure, demonstrated by its four-year (2008-2011) average net adjusted debt/EBITDAR ratio of 2.3x. Nevertheless, as of June 30, 2013, the company's net debt/EBITDA ratio was 3.1x, which compares unfavorably with 2.9x in 2012 and 2.1x in 2011. This increase in leverage basically reflects the lower business profitability as debt levels have been stable since 2011 at around BRL112 billion. Fitch's base case indicates a net adjusted leverage ratio of 2.8x in 2013 and 2.4x in 2014 as result of some improvements in services levels.
Weak Liquidity Position; Refinancing Risk in 2014 Should Be Addressed
As of June 30, 2013, DASA's total adjusted consolidated debt was BRL1.8 billion, which primarily consists of BRL960 million of local debentures, BRL65 million of senior notes and BRL586 million related to rental obligations. DASA has a low level of cash relative to short-term debt, a risk mitigated to a degree by the low volatility of its cash flow generation. As of June 30, 2013, DASA's cash and marketable securities was BRL236 million while its short-term debt was BRL343 million, which translated to a cash-to-short-term debt ratio of 0.7x. Cash plus CFFO-to-short-term debt was 1.3x for the period. Refinancing risk increases in 2014, as the company's BRL700 million debentures begin to amortize. During 2013, Fitch expects DASA to find alternatives to refinance most of its debt coming due in 2014 and 2015 in order to minimize its exposure to refinancing risks.
Approval from CADE of MD1's Merger Still Pending
Fitch expects a favorable outcome of DASA's merger with MD1 Diagnosticos S.A. from the anti-trust authority CADE, with few restrictions on its operations in Rio de Janeiro. During October 2011, DASA signed a reversibility agreement with CADE, in which CADE stated that the company could carry on with the incorporations but had to keep the brands separated. DASA is still operating nine different companies from MD1. The supply chain and logistics have been integrated but further synergies could be achieved with a favorable ruling by CADE.
Favorable Outlook for Brazilian Healthcare Industry
DASA's business is expected to continue to benefit from the long-term positive fundamentals of the under-penetrated Brazilian healthcare market. An improved socioeconomic environment during the last few years has increased per capita GDP levels, lowered unemployment, and enabled people to switch from public to private healthcare. The private healthcare industry mix is expected to grow from 25% to 30% of the population in 2017. Nevertheless, going forward, growth should come from the low-income segment, which may lead to some pressure in the mix of exams and on prices.
Rating upgrades could occur as a result of a successful switch in the company's business strategy that results in a sustainable recovery in EBITDA margins and CFFO. Sustained lower levels of leverage would also be viewed positively.
Ratings downgrades would most likely be driven by large debt-financed acquisitions that pressure the company's capital structure. A change in management's strategy with regard to its conservative capital structure could also lead to a downgrade, as could a deterioration in the company's reputation and leading market position.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 5, 2013).
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage