CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) of Gerdau S.A. (Gerdau) at 'BBB-' and National scale rating at 'AAA(bra)'. The Rating Outlook remains Stable. A full list of rating actions follows at the end of this release.
The affirmation reflects Gerdau's sustained ability to generate robust positive free cash flow (FCF) through economic and commodity cycles. The company's strong geographical diversification, flexible business model, and well-developed network of scrap procurement, coupled with a track record of conservative financial management further support Gerdau's investment-grade ratings.
The Stable Outlook reflects Fitch's expectation that Gerdau will remain FCF neutral to positive during 2016 and 2017 despite the sharp economic downturn in Brazil. Fitch's base case for Gerdau forecasts a net debt-to-EBITDA ratio of about 3.7x in 2016, declining to around 3.1x in 2017 and then dropping to around 2.5x in 2018. We expect Gerdau to maintain its proactive approach to liability management in order to avoid refinancing risks in 2017, while maintaining its robust cash holdings and a well-spread long-term debt amortization schedule.
KEY RATING DRIVERS
Key Strengths - Geographical Diversification and Production Flexibility
Gerdau's investment-grade ratings are supported by the company's position as the leading geographically diversified long-steel producer in the Americas, which cushions revenues from volatility associated with exposure to any single country. As of the first quarter of 2016, the company's LTM EBITDA of BRL4.3 billion was split by operations as follows: North America 40%, Brazil 31%, Latin America (excluding Brazil) 18%, and Specialty Steel (including Europe) 11%. The company also has a flexible production cost structure with 75% of output coming from mini-mills, which allows the company to open and close facilities quickly in response to market conditions.
High Leverage with Declining Trend
Gerdau's leverage metrics deteriorated during the last 12 months due to the depreciation of the BRL and its impact on gross debt, as well as the severe recessionary environment in Brazil. Gerdau's net debt-to LTM EBITDA ratio was 4.4x as of March 31, 2016. The company has stated its strategic plan to reduce its net leverage to below 2.5x in the medium term through a combination of improving SG&A costs, reductions in capital expenditures, and asset optimization measures.
Positive Free Cash Flow is Essential
Gerdau has a solid track record of generating positive FCF throughout the economic cycles. From 2013 to 2015, Gerdau generated BRL4.7 billion of FCF after BRL7.3 billion of capex and BRL1.2 billion of dividend payouts. Fitch projects Gerdau will generate lower CFFO during 2016 due to the weak operating environment; however, FCF is projected to remain positive at BRL1.4 billion in 2016 and BRL1.7 billion in 2017 mainly due to a large reduction in capex levels. Fitch estimates capex to decline to BRL1.5 billion in 2016 and BRL1 billion in 2017.
Adjusting for cash flow movements related to trading securities, Gerdau had positive FCF of BRL2.9 billion for the LTM ended March 2016 and BRL2.4 billion in 2015, which compares positively with the BRL333 million generated during 2014. A key reason for the strong cash flow generation was working capital inflows of around BRL2.4 billion and BRL2.8 billion for the LTM ended March 2016 and during 2015, respectively.
Severe Contraction in Brazil's Steel Market; Challenge to Maintain Profitable Exports
Steel producers in Brazil will continue to face further headwinds in the second-half 2016 and into at least mid-2017 as industry fundamentals remain weak amid the country's economic recession. Fitch expects Gerdau's exports to represent around 40% of the Brazilian operations during 2016 and 2017, an increase from historical levels closer to 20%. This will offset a portion of the volumes lost in the domestic market; however, it will negatively impact margins, as Gerdau's domestic Brazilian EBITDA margins are around 18% compared to the export market of 5%-12%.
--12% decline in steel volumes sold in Brazil;
--Average of 6% prices increase in 2016;
--16% decline in specialty steel market;
--EBITDA margin between 10%-10.5% for 2016-2018;
--Average EBITDA/ton of around BRL290 during 2016-2018;
--Strong liquidity position maintained during 2016-2018.
A downgrade or Outlook revision could occur if the company does not continue to generate positive FCF during the sharp economic downturn in Brazil, which should continue to last throughout 2016 and 2017. Gerdau's inability to reduce net leverage to around 2.5x by end of 2018 could also trigger a downgrade. New developments on the Zelotes Operations could also pressure Gerdau's ratings.
An upgrade or Positive Outlook is unlikely in the medium term considering Gerdau's current capital structure, still-large business concentration in Brazil and South America, and mid-level competitive position globally.
LIQUIDITY AND DEBT STRUCTURE
Gerdau has manageable refinancing risks and a strong liquidity profile. As of March 31, 2016, current cash of BRL5.5 billion covered debt amortization until mid-2017. The company has a high amount of debt coming due during 2017 (BRL4 billion) and Fitch expects Gerdau to proactively refinance this amount by early 2017 in order to avoid higher refinancing risks.
The company's cash plus CFFO-to-short-term debt coverage ratio was 4.5x for the LTM ended March 2016. We expect Gerdau to maintain a minimum cash balance of around BRL3 billion-BRL4.5 billion providing the company with comfortable liquidity headroom. In addition to its cash balance, Gerdau has access to a global revolving credit facility of USD1 billion, which, as of March 31 2016, had USD559 million available (BRL1.9 billion). As of March 31 2016 Gerdau's total debt of BRL24 billion was consisted mainly of cross-border issuances (66%) and working capital lines (30%).
FULL LIST OF RATING ACTIONS
Fitch affirms Gerdau's ratings as follows:
-- Long-Term Foreign currency IDR at 'BBB-';
-- Long-Term Local currency IDR at 'BBB-';
--Long-Term National rating at 'AAA(bra)'.
--Gerdau Holdings Inc. 7.00% notes due 2020 at 'BBB-';
--Gerdau Holdings Inc. 5.893% notes due 2024 at 'BBB-';
--Gerdau Trade Inc. 4.75% notes due 2023 at 'BBB-';
--Gerdau Trade Inc. 5.75% notes due 2021 at 'BBB-';
--GTL Trade Finance Inc. 7.250% notes due 2017 at 'BBB-';
--GTL Trade Finance Inc. 7.250% notes due 2044 at 'BBB-';
--GTL Trade Finance Inc. 5.893% notes due 2024 at 'BBB-';
--Port Authority of the City of St Paul (MN) Solid Waste Disposal Revs (Gerdau) 2012-7 'BBB-'.
The Rating Outlook is Stable.
Fitch has also assigned the following ratings:
Metalurgica Gerdau S.A (MG)
--Long-term National rating of 'AA+(bra)';
--Expected 'AA+(bra)' rating to BRL450 million convertible debentures issuance due 2019.
The Rating Outlook is Stable.
The 'AA+(bra)' ratings of MG reflect the structural subordination to Gerdau's debt as it operates as a pure holding company. MG holds 41% of Gerdau's total capital and 77% of the voting capital. As of March 31 2016, MG had BRL1.9 billion of debt, BRL440 million of short-term debt and BRL179 million in cash. The proceeds of the convertible debentures will be used primarily for debt refinancing.
Date of Relevant Rating Committee: July 7, 2016
Additional information is available at www.fitchratings.com
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
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