Author: AtlanticIS

Corporates

Companhia Siderurgica Nacional acquires Elizabeth Cimentos, improving diversity, a credit positive

AtlanticIS

Brazil, June 30, 2021 – Companhia Siderúrgica Nacional (CSN, Ba3 stable) announced that its fully owned cement subsidiary CSN Cimentos S.A. had entered an agreement to purchase Elizabeth Cimentos S.A. and Elizabeth Mineração Ltda. (collectively, Elizabeth Cimentos) for BRL1.08 billion ($220 million). The deal is credit positive for CSN because the additional capacity in the cement segment will help diversify its cash flow and foster growth, while hardly affecting its balance sheet and liquidity. The acquisition requires customary approvals, including from Brazil’s antitrust authority CADE.

CSN had a robust cash position of BRL18.2 billion at the end of March 2021, including its shares of Usinas Siderurgicas de Minas Gerais (Usiminas, Ba3 stable), and will report historically low leverage and generate free cash flow north of BRL10 billion in 2021, offsetting leverage and liquidity risks coming from this transaction. Additionally, the acquisition could be self-financed at CSN Cimentos’ level, assuming the successful conclusion of the subsidiary’s initial public offering (IPO), which will generate an estimated BRL2.5 billion and give CSN additional flexibility to pursue growth while also reducing debt during the peak of the steel and iron ore industries’ cycle this year.

The transaction involves the acquisition of a plant with an annual production capacity of 1.3 million tons that serves Brazil’s northeastern markets in the states of Paraíba and Pernambuco. This plant complements CSN Cimentos’ existing 4.7 million production capacity in Brazil’s southeast region in the states of Minas Gerais and Rio de Janeiro.

Pro forma for the transaction, CSN’s cement revenue has the potential to increase by about 30%, and the share of the cement segment in CSN’s consolidated results would increase to 3% of total revenue from 2% currently. Although still small relative to the group’s overall size, a larger footprint and scale in the cement business will provide a buffer to CSN’s consolidated cash flow during future downturns in the steel and iron ore markets, which contribute 51% and 42% to the company’s total revenue, respectively.

CSN’s adjusted EBITDA increased to BRL14.4 billion in the 12 months that ended March 2021 from BRL6.3 billion in 2019, and adjusted leverage declined to 2.4x from 4.8x on positive industry momentum. We expect CSN’s adjusted leverage ratios to decline to around 1x-2x over the next 12-18 months and to be within the 3.0x-4.5x range over time based on a range of price scenarios for iron ore 62% Fe of $70-$100 per ton and normalized steel operations. Net leverage, assuming a recurring BRL10 billion cash position, will fall to below 1x in 2021 and settle around 2-3x over time. Leverage ratios could strengthen depending on how much debt reduction the company pursues this year.

CSN’s credit quality and liquidity have improved materially since late 2020 amid a robust increase in cash and cash flow coming from strong steel and iron ore operations, and several liquidity-enhancing initiatives carried out by the company. These include the IPO of its mining subsidiary, the around BRL4 billion reduction in gross debt so far this year, the sale of about half of its preferred shares in Usiminas for BRL1.3 billion, the issuance of $850 million in new 10-year notes to tender the $925 million notes maturing in 2023, and the ongoing refinance of BRL3.4 billion in debt with Banco do Brasil S.A. and Caixa Economica Federal that come due in 2021-22.

Still, CSN’s track record of aggressive financial policies, including a highly leveraged capital structure, appetite for growth and dividend requirements to service debt payments at the parent level are key risks. However, we acknowledge that CSN is proving to be more conservative in its financial management and in preserving its credit quality even while pursing opportunistic acquisitions.

The acquisition will also help to consolidate Brazil’s fragmented cement market, improving the competitive landscape by rationalizing competition. Brazil has an annual installed cement production capacity of about 102 million tons, and had an annual consumption of 60 million tons in 2020. That is an improvement from the 2018 trough of 53 million tons, but still below the 2014 peak of 73 million tons peak. The sector has struggled with sequential contractions in cement demand since 2014, which led domestic cement prices to drop to a low of BRL25 per 50 kilogram bag in 2017-19, from nearly BRL35 in 2011.

Cement demand in Brazil was hard hit by lower residential construction derived from the country’s economic recession in 2015-16 and a retrenchment of public and private investments. In 2020, cement demand grew 10.9% from the previous year because of the strong performance of the self-construction segment and a pick-up of real estate construction activity, which together contribute to around 80% of the total cement consumption in Brazil. For 2021, cement demand growth will soften, reflecting less disposable income available for self-construction with the phase out of government support to individuals but still firm residential construction activity.

Credit Outlook: 5 July 2021. Pg. 8
Moodys

Banking

Peru allows state-guaranteed loans to be restructured, a credit positive for banks

AtlanticIS

Peru, March 9, 2021 – The Government of Peru (A3 stable) issued an emergency decree to allow banks to restructure loans under its state guarantee programs Reactiva Perú and FAE-MYPE until 15 July 2021 and also allow an additional 12-month grace period during which borrowers will repay only the interest portion of their loans.

By allowing banks to restructure existing Reactiva and FAE-MYPE loans through mid-July, allowing an additional grace period, and providing state guarantees for up to 98% of a loan (depending on its size), banks have strong asset-risk protection for longer. However, Peruvian banks also risk reduced interest income dragging down their margins.

The Reactiva Perú program was set up in April 2020 and is a PEN30 billion ($8.9 billion) state-guaranteed credit facility that provides working capital to small and midsize enterprises (SMEs) and large corporates. The program aims to relieve liquidity strain and limit the number of loan defaults among corporate and SME borrowers, which supports banks’ asset quality and the economy. The FAE-MYPE program targets small and micro agricultural producers and will be used by banks as well as credit cooperatives.

Under Reactiva, banks were awarded state guarantees in auctions that ensured the lowest rate for the end user for a 36-month loan with a 12-month grace period of no capital repayment. The government provides a guarantee to the lending bank for 80%-98% of the loan on a pro rata basis, depending on the size of the credit.Lending under the Reactiva Perú state-guarantee for corporations and SMEs now accounts for around 16.5% of total loans, according to Central Bank data. The program ended on 30 November 2020 which was the last date when state guarantees could be applied for.

Problem loans in Peru were 3.4% at year-end 2020, 75 basis points higher than year-end 2019 before the pandemic. However, government aid such as the Reactiva program is key to mitigate an expected deterioration in credit quality. The four largest banks in the market – Banco de Crédito del Perú (Baa1/Baa1 stable, baa21), Banco BBVA Perú S.A.(Baa1 stable, baa2), Banco Internacional del Perú – Interbank (Baa1/Baa1 stable, baa2) and Scotiabank Perú (A3 stable, baa3) – hold around 90% of total loans to midsize companies and almost 100% of total loans to SMEs and are the greatest beneficiaries of the Reactiva program.

However, the additional grace period will reduce Peruvian banks’ interest income as capital on restructured loans need not be paid, which will compress their net interest margins. We estimate that the average rate on Reactiva loans with a 24-month maturity is 1.6%, well below average rates on other loans. In 2020, bank net interest margins fell by 100 basis points as provisioning expenses rose 120%; net income to tangible assets fell to 0.4%, from the 2.1% 2016-19 average. With the ability to restructure loans and allow borrowers to pay only interest, the new measures will allow banks to keep their loan-loss provision expenses in check, which will aid their net income.

Under the new measures, loans of up to PEN90,000 can be restructured without any requirement, loans between PEN90,001 and PEN750,000 can be restructured if the borrower’s sales fell by 10% in the fourth quarter of 2020 versus fourth-quarter 2019 and for loans between PEN750,001 and PEN5 million, borrowers must show that fourth-quarter sales fell by 20% versus 2019.

Credit Outlook: 15 March 2021. Pg. 17
Moodys

Corporates

Carrefour’s cash-funded acquisition of Grupo BIG will strengthen its market position in Brazil

AtlanticIS

Brazil, March 24, 2021 – Carrefour S.A. (Baa1 negative) announced the acquisition of Brazilian food retailer Grupo Big S.A. for an enterprise value of around €1.1 billion, equivalent to an estimated 8x enterprise value/EBITDA multiple before synergies. The transaction is expected to close in 2022 following regulatory approval from the Brazilian authorities. Overall, we view the acquisition as credit positive for Carrefour because it will be funded by cash, reducing gross leverage once synergies are achieved, and strengthen its leading position in Brazil.

The acquisition will improve Carrefour’s business profile by increasing its overall scale and geographical diversification, in addition to strengthening its position in Brazil. Carrefour and Grupo BIG are the country’s largest and third-largest food retailers, respectively, and have complementary geographical coverage: Grupo BIG has a strong presence in the north-east and south of Brazil, where Carrefour currently has limited penetration. In addition, the similarity of Grupo BIG’s formats with Carrefour’s (mainly cash and carry and hypermarkets) will facilitate the companies’ integration.

Carrefour will finance the transaction through a mix of cash (70%) and equity (30%) and we expect it to have sufficient cash on balance sheet to fund the acquisition. As a result, Moody’s adjusted debt/EBITDA will decrease by around 0.2x pro forma for the transaction and taking into account around €260 million of run-rate EBITDA synergies that it expects to achieve over a three-year period. However, net debt will deteriorate slightly once the transaction completes because of the estimated €800 million acquisition cost. We also expect restructuring costs to partially offset the additional cash flow from Grupo BIG in the years following the transaction’s closing.

Credit Outlook: 29 March 2021. Pg. 4
Moodys

Corporates

Ecopetrol’s acquisition of ISA is credit positive

AtlanticIS

Colombia, January 27, 2021 – Ecopetrol S.A. (Ecopetrol, Baa3 stable) announced the acquisition of 51.4% of the capital of Interconexion Electrica S.A. E.S.P. (ISA, Baa2 stable). ISA is a publicly traded power company owned by the Government of Colombia (Baa2 negative). The transaction is credit positive for Ecopetrol because ISA generates a more stable EBITDA compared to that of Ecopetrol’s oil and gas commodity business, which increases cash flow visibility for Ecopetrol. Also, ISA operates in Colombia, Brazil, Peru and Chile, which reduces Ecopetrol’s geographic concentration risk; and Ecopetrol’s capital structure will not materially change after the completion of the acquisition transaction.

The acquisition of the controlling stake at ISA may cost approximately $4 billion. Because ISA is publicly traded, the acquisition amount should be based on market prices and on standard valuation practices, despite the Colombian government currently controlling Ecopetrol’s and ISA’s capital.

Ecopetrol’s plans to sell shares and assets as well as raise debt to fund the acquisition of ISA. The company expects that the combination of such initiatives will not deteriorate its credit metrics materially. We estimate that Ecopetrol’s debt/EBITDA ratio was around 3 times at year-end 2020 and that this credit metric will remain relatively stable in the next few years, pro-forma for the consolidation of ISA. Our estimate is based on an average Brent oil price of $45 per barrel (dpb) in 2021 and 50 dpb in the medium term.

We understand that after completion of the transaction, ISA will contribute with 15-20% of Ecopetrol’s consolidated EBITDA. We assume that the companies’ business strategies will not change materially and that their respective management teams, dividend policies and capital investment plans will remain mostly unchanged.

Ecopetrol is the largest integrated oil and gas company in Colombia. Ecopetrol has three business segments, namely exploration and production, refining activities and transportation and logistics. Its production averaged around 639,000 barrels of oil equivalent per day, net of royalties, in the 12 months that ended September 2020, and total assets amounted to $43 billion in September 2020. The Colombian government owns 88.5% of the company’s capital and the balance has been traded on the Colombian Securities Exchange since November 2007.

ISA, headquartered in Medellin, Colombia, is an operating holding company with businesses in the electricity transmission, toll roads, telecommunications, and systems management sectors. The company holds direct and indirect ownership stakes in a portfolio of subsidiaries located in Colombia, Brazil, Peru and Chile.

Credit Outlook: 1 February 2021. Pg. 5
Moodys

Banking

Google Pay expands into consumer banking, a credit negative for US banks

AtlanticIS

United States, November 18, 2020 – Google parent Alphabet Inc. (Aa2 stable) announced that it will launch Plex Accounts next year, a digital bank account offered within its Google Pay app in partnership with 11 US banks and credit unions. Google’s expansion into the distribution of consumer banking services is credit negative for US banks because it will increase competition for customer relationships, and in particular, competition for deposits, US banks’ primary funding source.

The launch of Google Pay Plex Accounts is an example of big tech’s expansion into retail financial services. It capitalizes on the rising popularity of digital wallets, an example of the widening application of digital innovations in financial services that we expect will continue to drive disruption across banking. Digital innovation and a flourishing financial technology sector present a threat to US banks.

Alphabet’s expansion into retail financial services distribution is consistent with our central scenario that large nonfinancial institutions intent on enhancing customer engagement will partner with incumbent banks to distribute financial services. Alphabet’s ability to partner with US banks and credit unions demonstrates the increasingly low barriers to entry for firms with large existing customer bases to distribute consumer financial services including deposit offerings. Digital innovation and changing customer behavior have lowered such barriers that historically included building out an expensive branch network.

US banks’ balance sheets are built on a foundation of low-cost, sticky deposits. Google Pay Plex Accounts will have no fees for monthly service, low balance, overdraft or in-network ATM use, and market its user-friendly interface and capabilities. Many US banks have similarly introduced online-only deposit products with low to no fees and/or high interest rates to capture additional deposits and customer relationships. Over time, increasing competition could raise deposit costs, pressure deposit fees and increase the need for banks to invest in emerging technology to attract or maintain customers. Failure to respond risks driving shifts in market share to those banks who best meet customer expectations.

The 11 US banks and credit unions partnering with Alphabet to offer Plex Accounts, including Citibank, N.A. (Aa3/Aa3 stable, baa11), would benefit from an inflow of consumer deposits and the potential to deepen new customer relationships. Citibank, N.A. and the other partnering banks will also have an early-adopter advantage in evolving their digital strategies to meet new customer needs. With the accelerating use of mobile payments and rising popularity of single-click digital wallets, incumbent banks need a strategy to stay in the customer-facing part of the payments business.

Alphabet will offer Plex Accounts within its own digital ecosystem, Google Pay, which provides a level playing field for partnering banks. However, the lack of friction within such a digital environment could ultimately increase competition among financial institutions, on and off the platform. Alphabet’s expansion into the distribution of financial services would align with big tech strategies to increase the scope and appeal of their digital platforms through enhanced customer engagement and a further strengthening of their consumer value proposition.

The launch also provides a blueprint for other firms with large existing customer bases keen to capture an increasing share of consumer activity and build customer loyalty. Increased user engagement enables these firms to capture valuable data and boost revenue. In our view, partnerships in which banks cede control of a large share of customer relationships pose the greatest risk to incumbent financial institutions. Such developments increase the risk of our alternate scenario, where big tech firms control a larger share of distribution and displace incumbents that fail to execute timely, effective digital strategies.

Credit Outlook: 23 November 2020. Pg. 16
Moodys