Fitch Affirms Galvao Participacoes's Ratings at 'B+/BBB+(bra)'; Outlook Stable

SAO PAULO--()--Fitch Ratings has affirmed the foreign and local currency Issuer Default Ratings (IDRs) of Galvao Participacoes S.A. (GALPAR) at 'B+' and its national long-term rating at 'BBB+(bra)'. Fitch has also affirmed the national long-term rating of its fully owned subsidiary Galvao Engenharia S.A. (GESA) at 'BBB+(bra)'. The Rating Outlook remains Stable. A complete list of rating actions follows at the end of this press release.

KEY RATING DRIVERS

The ratings for GALPAR and GESA incorporate the group's long and proven expertise on the engineering and civil construction sector, which is the main cash generator, and the positive business diversification. The Galvao group has potential improvements coming from the water and wastewater sector through CAB Ambiental S.A.'s (CAB) concessions and should benefit from the robust sector fundamentals of the toll road segment through the recent acquired concession of BR-153. The favorable outlook for the infrastructure sector in Brazil and GESA's scale as the sixth largest contractor in Brazil were taken into account. Fitch considers GALPAR's consolidated net leverage as moderate, which should be mitigated by a more robust cash position and the refinancing of the high short-term debt in the near future. The recent sale of energy assets was considered as positive to the group.

Ratings are constrained by the inherited volatility and cyclicality of the construction business and the large exposure to government clients, which demands high working capital to support erratic payments. Fitch also takes into account that the group generates the majority of its revenues domestically. The corporate governance practices need to improve.

The ratings of GALPAR and GESA are the same, given the mutual financial and operating support and cross guarantees provided. GESA should continue in the medium term to provide support to its affiliates in the form of debt guarantees, and indirectly through dividends streamed up to GALPAR.

FCF Momentarily Pressured

GALPAR and GESA FCF are momentarily pressured, but expected to improve in the short term. Over the LTM ended June 30, 2014, GESA generated a negative CFFO of BRL487 million, which unfavorably compares to a positive CFFO of BRL201 million in 2013. This result led GESA's FCF to a negative BRL764 million, which unfavorably compares to a negative FCF of BRL100 million in 2013. GESA's performance carried GALPAR's consolidated results in the same direction and magnitude. There is a natural mid-year effect that pressures results, as heavy constructors tend to receive most of its invoices from governmental clients only by year-end. The cash flow is also affected by the working capital needs of BRL980 million in the LTM, as GESA discuss some important claims with Petrobras in the amount of BRL830 million. Fitch understands that delays in receiving claims is part of the heavy construction business and expects FCF to normalize at the end of 2014.

Tight Liquidity, Expected to Improve

GALPAR and GESA closed mid-year results with a low cash coverage. As of June 30, 2014, GALPAR and GESA reported, on a consolidated basis, cash positions of BRL272 million and BRL183 million, respectively, which covered only 32% and 49% of their short term debts of BRL847 million and BRL371 million. In contrast, coverage ratios reached 123% and 307% in Dec. 31, 2013. On the debt side, the pressure comes from the short-term debt used by CAB Cuiaba S/A and other units of CAB Ambiental to support the concessions' payments. Fitch expects these loans to be replaced by long-term debt in the short-term. On the cash side, the aforementioned delays in receiving claims and the seasonal mid-year effect also pressured liquidity. Fitch anticipates an improvement in GALPAR's and GESA's liquidity towards the YE14.

Adequate Capital Structure

Fitch expects GALPAR and GESA to maintain an adequate capital structure in the foreseeable future. As of June 30, 2014, consolidated net leverage was 3.8x and 3.2x, respectively, which favorably compares to 8.5x and 4.4x reported in June 30, 2013. As of Dec. 31, 2013, net leverage reached 2.3x and 1.4x, respectively, and Fitch believes a direct comparison of June and December figures is hindered by the intrinsic mid-year seasonality of the sector.

Positive Business Diversification

Fitch believes Galvao Group will continue to analyze opportunities in water/wastewater sector, as well as in logistic concessions (roads, railways, ports, airports, among others) over the next years. Fitch views this initiative as positive, as in the first moment these projects generate backlog for GESA, and in the future they will provide the group with a more predictable revenues to smooth the inherited volatility of the construction business. Those businesses tend to have better EBITDA margin than the construction segment. In the LTM ended on June 30, 2014, GALPAR revenues reached BRL4 billion and EBITDA of BRL503 million led to an EBITDA margin of 12.7%.

Robust Backlog Secures Revenues

Fitch believes that GESA robust backlog improves revenue visibility over the next two to three years. The company ended June 2014 with a robust BRL9.2 billion backlog, equivalent to 2.3 years of operation, all else held equal. This favorably compares to the BRL6.6 billion (1.6 year) at the end of 2013. The growth came mainly from the BR-153 EPC contract. On the other hand, the fact that GESA operates predominately in Brazil, makes it more exposed to local economic downturns compared to some of its peers that generate from 30% to 70% of their revenues abroad. The company has been able to reduce its backlog concentration by capturing new contracts and clients. For instance, GESA has reduced the backlog exposure from Petrobras to less than 20% in June 30, 2014 from 50-60% in Dec. 31, 2011.

No Dividends Over the Next Five Years

GALPAR, which is the ultimate company of the group before the family holdings, will not distribute dividends over the next three to five years. The same decision has been applied to CAB. The rationale is to create a cash cushion to support the expansion of the group in the water & sewage segment and logistic concessions (roads, railways, ports, airports, among others). The only unit that will continue to pay dividends is GESA. Fitch sees this decision as supportive for the current ratings.

RATING SENSITIVITIES

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

--Significant backlog reduction and interruption of relevant works;

Galpar's consolidated cash/short-term debt consistently below 0.8x;

Galpar's consolidated net leverage above 4.5x.

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

--Relevant improvements in the group's operational performance;

--Consistence maintenance of adequate operating margins combined with robust liquidity and lengthened debt maturity profile;

--Galpar's consolidated net leverage below 3.5x on a consistent basis;

--Improvements in Corporate Governance.

Fitch has affirmed GALPAR and and GESA's ratings as follows:

Galvao Participacoes S.A. (GALPAR)

--Long-term foreign currency IDR at 'B+';

--Local currency IDR at 'B+';

--Long-term national rating at 'BBB+(bra)';

--BRL300 million senior guaranteed notes due 2020 at 'BBB+(bra)';

Galvao Engenharia S.A. (GESA)

--Long-term national rating at 'BBB+(bra)';

The Rating Outlook for the corporate ratings is Stable.

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

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 28, 2014);

--'National Scale Ratings Criteria' (Oct. 30, 2013).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

National Scale Ratings Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=720082

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=890394

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

Contacts

Fitch Ratings
Primary Analyst
Alexandre Garcia
Associate Director
+55-11-4504-2616
Fitch Ratings Brasil Ltda.
Alameda Santos, 700 - 7th floor - Cerqueira Cesar
Sao Paulo - SP - CEP: 01418-100
or
Secondary Analyst
Gustavo Mueller
Associate Director
+55-12-4503-2632
or
Committee Chairperson
Mauro Storino
Senior Director
+55-21-4503-2625
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Alexandre Garcia
Associate Director
+55-11-4504-2616
Fitch Ratings Brasil Ltda.
Alameda Santos, 700 - 7th floor - Cerqueira Cesar
Sao Paulo - SP - CEP: 01418-100
or
Secondary Analyst
Gustavo Mueller
Associate Director
+55-12-4503-2632
or
Committee Chairperson
Mauro Storino
Senior Director
+55-21-4503-2625
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
elizabeth.fogerty@fitchratings.com