Fitch Affirms Cementos Pacasmayo S.A.A. at 'BBB-'; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed the ratings of Cementos Pacasmayo S.A.A. (Pacasmayo) at 'BBB-'. The Rating Outlook remains Stable.

The ratings reflect the company's solid business position as the only cement producer in Peru's northern region. This position has resulted in high margins, low leverage and solid liquidity. The small size of the cement market in the north, as well as the logistical challenges found in this region, have limited the impact of imports and the probability that a global company will enter the region in the near future. Further factored into the ratings is the completion of Pacasmayo's new cement plant in Piura and the favorable outlook for Peru's cement industry over the medium term driven by Peru's positive macroeconomic and business environment.

KEY RATING DRIVERS

Solid Business Position

Pacasmayo is the dominant player in Peru's northern region, where it provides essentially all of the cement sold in the area. During the last-12-month (LTM) period ended in June 2016 the company sold 2.4 million metric tons of cement, maintaining its historical market share in Peru's cement industry of approximately 20%. Positive for credit quality, the market structure has remained stable in Peru for more than a decade. Pacasmayo's low cost production and extensive distribution network which is customized to the specificities of the Peruvian cement market give the company strong competitive advantages and provide barriers to entry.

Proposed Separation of Cement Business and Phosphate Project

Fitch views the proposed separation of the cement business from the company's phosphate project favorably, as it isolates the operations, financing, and risks associated with the cement group from this mining project. Pacasmayo announced a proposal to separate its cement operations and the company's 70% ownership of Fosfatos del Pacifico (phosate project) into its own separate, publicly traded company on Aug. 22, 2016. The new company will be incorporated as FOSSAL, and will be publicly listed on the Lima Stock Exchange, and will fully separate the cement operations from the phosphate project. Pacasmayo's 70% share of the project will be transferred to FOSSAL, while the remaining 30% stake will still be owned by MCA Phosphates PTE, a division of Mitsubishi Corp. Also under the proposed terms, Pacasmayo will contribute around USD12 million of cash to FOSSAL. Total expected investment in the phosphate project is expected to be more than USD800 million and would take five years to procure, construct, and start-up. The phosphate project still requires an operating partner to join the endeavor.

Return to FCF Generation and Improved Leverage Metrics

Fitch projects Pacasmayo will return to neutral/positive free cash flow generation during 2016 due to steady growth in operating cash flow coupled with a significant reduction in capex. Fitch projects FCF to be approximately positive USD4 million in 2016 and increasing to around USD20 million in 2017. Pacasmayo's net leverage ratio is projected to improve to 2.0x by 2016 and around 1.7x by 2017 from 2.2x as of June 30, 2016. Net leverage in 2017 could decline further if EBITDA grows at a higher than expected pace or the company announces lower dividends than the levels paid in 2016 and 2015, allowing the company to increase its liquidity level.

Lower Liquidity Eventually Improve

Pacasmayo's cash position declined to USD37 million as of June 30, 2016 compared to USD46 million at Dec. 31, 2015, and USD192 million at Dec. 31, 2014 due to the funding of its new plant and 2015 dividends of USD51 million. Fitch expects Pacasmayo will end 2016 with a cash balance of around USD40 million mainly due to an increase in positive FCF generation over the next six months, partially offset by 2016 dividends of around USD50 million and Pacasmayo's contribution of approximately USD12 million to the phosphate business. Pacasmayo is expected to return to neutral/positive free cash flow (FCF) generation by year end 2016 and through 2019, replenishing its cash balances to approximately USD60 million by 2017 and USD76 million by 2018. Increased future dividends, share buy-back programs, or opportunistic acquisitions could hamper the company's ability restock its liquidity levels. The company has no short-term debt, with its USD300 million notes not maturing until 2023.

Expanding Margins

Fitch projects slight EBITDA margin improvement for Pacasmayo to around 32% for 2016 compared to 31.7% in 2015, which should benefit from its lower cost cement plant in Piura over the coming years. EBITDA margins for the six months ended June 30, 2016 were negatively impacted as Pacasmayo had to import 96,518 tons of clinker during 1Q16 while its Piura plant was still ramping up its clinker production. Margins were also negatively impacted due to lower utilization rates and increased depreciation form the new plant start up. Key factors in sustaining its high margins include: access to low-cost energy, proximity of cement plants to limestone reserves, extensive and well-developed distribution network, and a favorable sales mix of bagged (89% of demand) to bulk (11% of demand) cement.

Ramp-up of Piura Cement Plant

Pacasmayo's new facility in Piura is increasing its capacity utilization levels with cement production up 89% at 229,100 metric tons in 2Q16 from 1Q16 and clinker production up 103% at 164,000 metric tons in 2Q16 compared to 1Q16. Total capacity of the plant is 1.6 million tons of cement and 1.0 million tons of clinker. Advantages of the new Piura plant include the elimination of the need to import clinker for cement production which the company stopped importing in 2Q16, and the location of the plant provides Pacasmayo with greater logistical flexibility in regards to meeting the demands from different regions of Northern Peru. Total capex of USD365 million, and was approximately USD20 million under budget.

Favorable Cement Industry Fundamentals

Fitch projects Peruvian cement consumption in the northern region to increase by at least 3.5% during 2016 due to increased demand from self-construction and continued demand from public/private sector markets. The housing and construction sector is projected to see a boost due to a new Peruvian law allowing 25% of individual pension funds can be used for first home down payments. The presidential election of Pedro Pablo Kuczynski of the Peruvians for Change party is favorable for the industry as he has initially demonstrated business friendly and open-market policies that are positives for the continuity of Peru's current economic environment. Approximately USD24 billion is expected to be invested in capital projects over the next 5 years in Peru's northern region, of which USD7 million are already in execution or public bid. Furthermore, the limited disruption to construction activities from the El Nino earlier in 2016 was also a positive to the industry fundamentals.

KEY ASSUMPTIONS

--Cement volumes to increase at least 3.5% in 2016 and 2017.

--Price increases remain in line with inflation.

--Consolidated EBITDA margin to improve to over 32% in 2016 due steady demand and reduced imported clinker.

--Capex to decline significantly to around maintenance levels.

RATING SENSITIVITIES

Pacasmayo's rating or Outlook could be negatively affected by an inability to generation positive free cash flow to restore liquidity levels. Aggressive future dividends or share buy-back programs over a prolonged period could hamper its capital structure. An inability, or unwillingness to reduce leverage to around 1.5x by 2017 could also result in a negative rating action.

A positive rating action is unlikely over the near term given Pacasmayo's need to improve its liquidity following its heavy capex cycle and reduce net leverage. Pacasmayo's small size and lack of geographic diversification also impede an upgrade in the near term, despite the monopoly position it holds in Northern Peru.

LIQUIDITY

Pacasmayo's cash position declined to USD37 million as of June 30, 2016 compared to USD46 million at Dec. 31, 2015, and USD192 million at Dec. 31, 2014 due to the funding of its new plant and 2015 dividends of USD51 million. Fitch expects Pacasmayo will end 2016 with a cash balance of around USD40 million mainly due an increase in positive FCF generation over the next six months, partially offset by 2016 dividends of around USD50 million and Pacasmayo's contribution of approximately USD12 million under the proposed terms of its phosphate business spinoff reorganization. Pacasmayo is expected to return to neutral/positive free cash flow (FCF) generation by year end 2016 and through 2019, replenishing its cash balances to approximately USD60 million by 2017 and USD76 million by 2018. Increased future dividends, share buy-back programs, or opportunistic acquisitions could hamper the company's ability restock its liquidity levels. The company has no short-term debt, with its USD300 million notes not maturing until 2023. Approximately 70% of Pacasmayo's cash is denominated in USD. All of Pacasmayo's debt outstanding is related to its bond issuance from 2013, which matures in February 2023. Pacasmayo has a cross-currency swap contract for its USD300 million denominated debt on the principal.

FULL LIST OF RATING ACTIONS

Fitch affirms the following:

Cementos Pacasmayo S.A.A.

--Long-Term Foreign Currency Issuer Default Rating (IDR) at 'BBB-';

--Long-Term Local Currency IDR at 'BBB-';

--Senior unsecured USD300 million notes due 2023 at 'BBB-'.

The Rating Outlook is Stable.

Date of Relevant Rating Committee: Aug. 31, 2016

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/site/re/869362

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Contacts

Fitch Ratings
Primary Analyst
Phillip Wrenn
Associate Director
+1-312-368-2075
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Josseline Jenssen
Director
00 511-372 0681
or
Committee Chairperson
Joe Bormann, CFA
Managing Director
+1-312-368-3349
or
Media Relations
Alyssa Castelli
+1-212-908-0540
New York
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Phillip Wrenn
Associate Director
+1-312-368-2075
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Josseline Jenssen
Director
00 511-372 0681
or
Committee Chairperson
Joe Bormann, CFA
Managing Director
+1-312-368-3349
or
Media Relations
Alyssa Castelli
+1-212-908-0540
New York
alyssa.castelli@fitchratings.com