Fitch: Challenges Await Chilean Corporates in 2015

CHICAGO--()--Despite the Stable Outlooks for a bulk of the Chilean portfolio of international corporate ratings, downgrades are expected to outpace upgrades during 2015 and Negative Outlooks are likely to increase, according to Fitch Ratings.

Macroeconomic conditions remain challenging and domestic demand should be subdued. Energy costs are elevated and will not decline in the near term. Prices for iron ore and pulp remain depressed, while copper prices are trending negative as supply is increasing. Tax changes will add additional pressure to 2015 corporate cash flows.

Fitch projects that the median net leverage ratio of its portfolio of 27 internationally rated corporates will climb above 3.2x by the end of 2015. This projected leverage level is considerably worse than 2.2x at the end of 2009 and compares negatively versus 3.0x during 2013. If leverage increases as projected, a number of downgrades could occur, as several credits are considered weak within their rating categories. Only four corporates among the rated portfolio are not rated investment grade - Automotores Gildemeister ('CCC'), LATAM Airlines ('BB'), GeoPark ('B') and Masisa ('BB').

Cencosud ('BBB-') and LATAM Airlines remain on Outlook Negative at the end of 2014, while CFR's rating is on Rating Watch Positive following its acquisitions by Abbott Laboratories. Default risk is the highest for Automotores Gildemeister. The Rating Outlook for the other 23 corporates remains Stable. Debt amortizations are very manageable. Ten corporates have tapped the international debt capital markets during 2014 to take advantage of attractive market conditions, using the proceeds mostly to finance upcoming maturities. Only Arauco ('BBB'), Endesa ('BBB+') and Telefonica Moviles Chile ('BBB+') face international bond bullet payments in 2015.

A wild card in rating activity is the direction and level of change in the Chilean peso, which floats more freely than other FX rates in the region and is a key component of profitability for corporates in the agriculture, mining, wine and pulp sectors. The FX rate also determines the competitiveness of manufacturing companies that compete versus imports. The Chilean economy is the most open to foreign trade in Latin America; exports plus imports are equivalent to nearly 70% of GDP.

Management teams are expected to remain aggressive to the detriment of creditors in 2015. This is a continuation of philosophical changes with regards to the optimal capital structure that has occurred over the past few years and has contributed to several downgrades. Many Chilean finance teams do not feel they are compensated for maintaining capital structures in the 'BBB+' to 'A' rating range. Therefore, they are funding capex and acquisitions with more debt. This is in contrast to the 1990s, when growth was funded with equity. At that time, owners and managers were cautious about using debt due to high default levels in the 1980s. In addition, IPO's were prevalent as corporates began tapping international capital markets.

Cash flow from operations growth for the group of credits has been anemic. The 27 Fitch-rated corporate issuers generated $18.8 billion of operating cash flow during 2013, which remains relatively unchanged from $18.1 billion in 2009. This lackluster level of cash generation growth occurred despite $68 billion of capital expenditures. Due to increasing capex during a period of flat operating performance, the median free cash flow ratio of these rated corporates fell to negative 2.2% in 2013 from positive 4.3% in 2009.

Corporate cash generation should continue to be lethargic in 2015, as the outlook for revenue growth is poor and companies face rising costs. Prices for key international commodities such as iron ore and pulp are at cyclical lows despite growing demand due to a global glut of new projects. A surplus of copper supply is expected in 2015, which could soften prices for this crucial commodity.

Business confidence has suffered from the approval of tax reforms, which dramatically changed the existing tax framework, and were particularly harsh on the treatment of retain earnings. Domestic demand has not grown as anticipated to offset external weakness. Fitch lowered its 2014 GDP expectation for the Chilean economy to 1.8% from 4.1% earlier in the year. Growth is predicted to pick up to 2.6% in 2015.

High energy prices are not expected to abate in the near future. Chile faces significant challenges in securing reliable sources of power at competitive prices, as energy prices are driven by uncontrollable variables such as hydrology and international prices of fuels. Growing energy demand and a deceleration of generation investments continues to support high prices. Both the energy agenda and tax reform measures support the expansion of LNG capacity and renewable energy versus lower cost energy derived from coal and large hydropower investments.

Taxes reform measures taken during 2014 will affect all companies negatively during 2015, although to varying degrees. The corporate tax rate will progressively increase from 20% in 2013 to 25% in 2017 for the companies that select to use the income attributed tax regime; for those that select the partially integrated tax regime, it will increase from 20% in 2013 to 27% in 2018. Certain tax changes related to the real estate sector could hurt construction companies during 2015. Alcohol and soft drink companies faced immediate increases in excise taxes. Consumer product companies will attempt to pass along higher taxes to their consumers. Companies in global industries such as mining, forestry, agriculture and fishing will face a slight weakening of their global competitiveness.

Free cash flow will likely remain negative for the majority of companies during a period of weak operating performance. Dividends and capex won't decline to the level needed for positive free cash flow and declining leverage trends. In fact, the recently enacted tax reform measures now make it more likely that dividends will increase, not decrease.

During the past five years, the median ratio of capex to depreciation for Chilean corporates has ranged between 1.4x to 1.7x. Declining business confidence could result in a scaling back of future projects. In addition, the approval process for new investments has increased its complexity. Public concern for environmental issues translated into greater judicial, political, and regulatory oversight of important projects. Companies need to seek increased participation of neighboring communities and engage in public debate on high impact projects, mainly those focused on extractive and energy industries. The risk of not managing these projects successfully is high and can be translated into the stoppage of projects and working operational units.

Additional information is available at 'www.fitchratings.com'.

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Contacts

Fitch Ratings, Inc.
Joe Bormann, CFA
Managing Director
Corporates, Latin America
+1-312-368-3349
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Rina Jarufe
Senior Director
+56-2-2-499-3310
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings, Inc.
Joe Bormann, CFA
Managing Director
Corporates, Latin America
+1-312-368-3349
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Rina Jarufe
Senior Director
+56-2-2-499-3310
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com