Fitch Downgrades Grupo IDESA to 'B'; Outlook Stable

CHICAGO--()--Fitch Ratings has downgraded the Long-Term Issuer Default Ratings (IDRs) of Grupo IDESA, S.A. de C.V. (IDESA) to 'B' from 'BB-'. The Rating Outlook has been revised to Stable from Negative. A complete list of ratings actions follows at the end of this press release.

The rating downgrade is based on expectations of continued pressure to IDESA's petrochemical operations due to deteriorating spreads in core products that combined with higher debt should result in very weak leverage ratios through 2018. IDESA's EBITDA is expected to decline to about USD45 million during 2016 from USD74 million a year ago. Meanwhile IDESA's debt has increased by about 50% to USD437 million as of June 30, 2016.

The increase in debt has been used to support funding requirements for its 25% share of Etileno XXI, IDESA's joint venture with Braskem that started operations in March. Dividends from this joint venture are restricted by project financing until certain financial and operating benchmarks are achieved. Fitch's base case does not assume material dividends from Etileno XXI until 2019.

The 'RR3' Recovery Rating (RR) on the notes reflects good recovery prospects in event of default. The above average recovery estimates reflect the value of IDESA's 25% stake in Etileno XXI.

KEY RATING DRIVERS

Weak Expected FCF generation

IDESA's CFFO remained relatively stable during 2014-2015 at around USD35 million despite lower product prices, primarily due to equally lower feedstock prices and the positive effect of the appreciation of the U.S. dollar against the Mexican peso on the company's profitability. Feedstock prices, which are somewhat more correlated to the price of ethane, have not declined in similar proportion during the LTM hurting IDESA's profitability. As a result, FCF has declined from about USD30 million per year to USD4 million as of the LTM as of second-quarter 2016. Fitch expects IDESA to continue to generate neutral to negative FCF during 2016-2017. FCF generation and incremental debt was mainly used to fund joint venture investments of about USD350 million during 2013 to 2016.

Elevated Leverage

IDESA's gross leverage was 5.4x at year-end 2015 and 8.9x as of second-quarter 2016, respectively. Increasing leverage has been a combination of severely contracting petrochemical spreads and to less extent declining production volumes. Fitch's base case suggests leverage should remain elevated in 2016-2017 at around 10x as underlying petrochemical spreads remain fragile. Leverage should decline to still relatively elevated levels below 7x by 2018 as cash flows from JV investments are received. Equity contributions from current or new shareholders would be viewed positively for credit quality.

High Reliance on Commodity Chemicals

IDESA has limited pricing power with its suppliers and customers, as the company's main product prices are based on international reference prices and somewhat correlated to the price of oil. Positively, the price of ethane-based ethylene oxide (EO), IDESA's main raw material, has also declined with lower natural gas prices. Fitch expects only modest upward pricing pressure in EO due to the wide availability of ethane in North America.

Strong Business Position Domestically

IDESA generates the majority of its EBITDA from ethylene glycols (EG) and ethanol amines (EA), product lines in which the company maintains a dominant position. In EG, where domestic demand outstrips supply, the company is Mexico's largest producer, with 32% of domestic market share. In EA, IDESA serves 60% of the domestic market, exporting close to 60% of its production to Europe, Asia and South America.

Country, Production Site and Supplier Concentration

About 90% of IDESA's total revenues come from the Mexican domestic market. Production capacity is heavily concentrated in its Coatzacoalcos plant, which is dependent on smooth operations at Pemex Petroquimica (PPQ), IDESA's sole supplier of EO. IDESA's participation in Etileno XXI should significantly diversify IDESA's cash flow sources and is considered positive for long-term credit quality.

KEY ASSUMPTIONS

--Revenues in USD fall about 15% during 2016 reflecting weak product pricing, partially offset by stronger sales volumes in distribution. For 2017 - 2018, revenues increase mid-high single digits trending upwards with Fitch's Brent oil price deck expectations of USD45 and USD55, respectively.

--EBITDA contracts to around USD45 million in 2016 and remains under pressure during 2017-2018 reflecting weaker petrochemical spreads partially mitigated by stronger margins in IDESA's distribution business.

--Cash flows received from joint ventures during 2018 support deleveraging.

RATING SENSITIVITIES

Future developments that may, individually or collectively, lead to a negative rating action include:

--Failure to ramp up of Etileno XXI's capacity utilization to levels above 85% by early 2018;

--Lower than expected polyethylene spreads that result in lower than expected cash flows to IDESA;

--Underlying weak cash flow generation that results in EBITDA declining below USD40 million.

Future developments that may, individually or collectively, lead to a positive rating action include:

--Material dividends from Etileno XXI received during the earlier part of 2018;

--Capital infusions that result in gross leverage levels around 5x would be considered positive for credit quality.

LIQUIDITY

IDESA's intrinsic liquidity is tight. CFFO has declined from USD35 million a year ago to USD19 million as of the LTM to second-quarter 2016. Expected negative FCF will likely need to be funded with USD29 million in cash and marketable securities. The company's main debt obligations are its USD300 million senior unsecured notes due in 2020 and bank debt. IDESA has USD26 million available undrawn from a contracted USD130 million committed credit line with Banco Inbursa. This credit line ranks equal in right of payment to existing unsecured debt and will likely be used to partially refinance USD31 million of short-term debt. Interest payments under this loan are due at maturity in 2020 which should provide some near-term flexibility.

FULL LIST OF RATING ACTIONS

Fitch has downgraded the following ratings:

IDESA

--Long-term foreign currency IDR to 'B' from 'BB-';

--Long-term local currency IDR to 'B' from 'BB-';

--USD300 million senior unsecured notes due 2020 to 'B+/RR3' from 'BB-';

The Rating Outlook is Stable.

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

Applicable Criteria

Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
https://www.fitchratings.com/site/re/885629

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Contacts

Fitch Ratings
Primary Analyst:
Gilberto Gonzalez, CFA, +1-312-606-2310
Associate Director
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst:
Rogelio Gonzalez, +52 81-8399-9100
Director
or
Committee Chairperson:
Joe Bormann, CFA, +1-312-368-3349
Managing Director
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
New York
elizabeth.fogerty@fitchratings.com