Fitch Assigns First-Time 'BB+' IDRs to Rede D'Or; Outlook Stable

SAO PAULO & CHICAGO--()--Fitch Ratings has assigned first-time foreign and local currency long-term Issuer Default Ratings (IDR) of 'BB+' to Rede D'Or Sao Luiz S.A. (Rede D'Or). In conjunction with this rating action, Fitch has assigned the company a National Scale long-term rating of 'AA(bra)'. The Rating Outlook is Stable.

KEY RATING DRIVERS

Rede D'Or's ratings reflect its strong competitive position in the fragmented hospital industry in Brazil, the defensive nature of its business fundamentals across economic cycles, and its track record of maintaining a solid liquidity position. The company's ratings also incorporate its large business scale, which has given it a strong bargaining power with counterparties. The needs for constant investment in technology and equipment renewal as well as potential regulatory issues are seen as manageable risks.

Rede D'Or's aggressive growth strategy via acquisitions currently constrains the ratings. Fitch expects the company to maintain this strategy due to the growth-oriented profile of its main shareholders and the consolidation trends in the industry. Rede D'Or's desire to expand should limit deleveraging trends in the medium term. Fitch forecast the ratio net adjusted leverage to EBITDAR to be below 3.0x in the next three years.

Fitch believes Rede D'Or's operating performance will not be materially affected by Brazil's economic downturn. Among the company's main challenges will be its ability to efficiently manage working capital needs since its customers may experience more pressure on their cash flow.

Robust Business Profile; Competition Should Increase

Rede D'Or is one of the largest private hospital networks in Brazil's fragmented and underdeveloped hospital industry. The company owns 28 hospitals and manages two others. The company has solid business positions, with ample scale differential in the regions where it operates: Rio de Janeiro, Sao Paulo, Brasilia and Recife. Business scale is a key issue in this industry and supports the ratings of Rede D'Or, as it allows fixed costs dilution and provides significant bargaining power with counterparties and medical community in general.

The geographic concentration of the company in Rio de Janeiro and Sao Paulo is partially mitigated by robust economic activity in these regions, as well as the strength of the health insurance companies. Nevertheless, the concentration in these two cities makes the company more vulnerable to new entrants. Since early 2015, there is a new regulatory framework for the Brazilian hospital industry that allows foreign interest-ownership, which should boost competition in the medium and long term.

Rede D'Or is expected to continue to seek both organic and inorganic growth. The company has an aggressive track record of acquisitions. From 2010 to May 2015, Rede D'Or acquired 16 hospitals, adding 2.6 thousand operating beds. Since April 2015, Rede D'Or counts with a new shareholder HPT Participacoes SA (Carlyle Group), which agreed to a BRL1.8 billion capital increase. The transaction was divided into two tranches, one of BRL875 million, which was received in April 2015. The second payment of BRL945 million will be received in April 2016.

Profitability Improvements; Working Capital and Investment Pressure FCF

Rede D'Or has been efficient in increasing profitability through economies of scale and achieving synergies from its acquisitions. The company's net revenue grew 169% between 2011 and the 12 months period ended in June 30, 2015, while the average operating beds expanded by 114% to 3.3 thousands. During this period its occupancy rate increased to 81% from 75%, while its EBITDAR margin expanded to 23% from 18%. Rede D'Or operating margin is amongst the highest of its hospital peers globally.

Rede D'Or successfully increased its operating cash generation, measured by EBITDAR, to BRL1.3 billion in the latest 12 months (LTM) June 2015 from BRL373 million in 2011. While its funds from operations (FFO) were BRL1.1 billion during the LTM, its cash flow from operations was only BRL307 million due to high working capital requirements. Free cash flow (FCF) generation has been historically negative - averaging negative BRL400 million between 2011 and June 2015. Fitch does not expect significant deviation on these figures over the next three years, as the company has plans to double its capacity to 8.6 thousand operating beds by 2019.

Deleverage Trend

Most of Rede D'Or's growth has been financed through debt. The average FFO adjusted leverage by the Rede D'Or was 3.0x as of June 30, 2015, while its net adjusted debt/EBITDAR ratio was 3.0x. These ratios compare with averages of 4.9x and 4.5x, respectively, between 2011 and 2014. The recent capitalization of BRL928 million and the additional tranche of BRL945 million to be received in April 2016 will improve Rede D'Or's capital structure. On a pro forma basis, considering the second tranche in cash, net adjusted leverage, measured by net adjusted debt/EBITDAR, is 2.3x. On Fitch's base case scenario, the company should continue to benefit from the improvements on its operating cash flow generation and be able to maintain net adjusted leverage ratios below 3.0x in the next three years.

KEY ASSUMPTIONS

--BRL2 billion in acquisitions up to 2018;

--EBITDAR margins of around 22.5%;

--Improvements on working capital needs, declining to around 5% net revenues;

--Average capex of BRL700 million up to 2018;

--Dividends of 25% net income;

RATING SENSITIVITIES

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

--EBITDA margins falling and remaining below 20%;

--Net adjusted leverage above 3.5x;

--Deterioration of sound liquidity position, with cash/short-term debt ratio below 1.0x on consistent basis, leading to refinancing risk exposure;

--Large M&A acquisition that moves the company's leverage beyond 3.5x, on a sustainable basis.

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

--More conservative approach on acquisitions;

--Operating margins consistently around 24%;

--Sustainable positive FCF generation;

--Net adjusted leverage below 2.5x, on consistent basis;

--Maintenance of strong liquidity position, with cash/short term debt above 1.0x on consistent basis.

LIQUIDITY

Rede D'Or has a track record of keeping strong cash balances, with an average coverage of cash to short-term debt of 6.3x during the last five years. As of June 30, 2015, the company had BRL1.2 billion of debt, of which BRL771 million is due in the short term. Rede D'Or's cash on hands plus the second tranche to be received from Carlyle in April is sufficient supports debt amortization up to 2017. The company counts with an additional liquidity coming from a pre-approved and available credit line with IFC of USD200 million and EUR50 million that should be used to support planned investments.

Date of Relevant Rating Committee: Oct. 29, 2015.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Additional Disclosures

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=993192

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Contacts

Fitch Ratings
Primary Analyst
Debora Jalles
Director
+1-312-606-2338
Fitch Ratings Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Renato Donatti
Associate Director
+55-11-4504-2215
or
Committee Chairperson
Ricardo Carvalho,
Senior Director
+55 21 4503-2627
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Debora Jalles
Director
+1-312-606-2338
Fitch Ratings Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Renato Donatti
Associate Director
+55-11-4504-2215
or
Committee Chairperson
Ricardo Carvalho,
Senior Director
+55 21 4503-2627
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com