Fitch Ratings-New York-23 March 2018: Fitch Ratings has affirmed LATAM Airlines Group S.A.'s (LATAM) Long-Term Foreign Currency Issuer Default Rating (IDR) at 'B+'. In addition, Fitch has affirmed TAM S.A.'s (TAM) Foreign and Local Currency IDRs at 'B+'. Fitch has also affirmed LATAM's unsecured notes at 'B+'/'RR4'. The Rating Outlook for the corporate ratings has been revised to Positive from Stable. A full list of rating actions follows at the end of this release.
The rating action encompasses LATAM's 2017 financial performance -- in line with expectations previously incorporated in the ratings -- including improved operational margin at 7%, USD732 million in positive free cash flow generation, important debt reductions, lower financial leverage and consistently high liquidity.
The Positive Outlook is supported by Fitch's expectations that the improvement in the company's credit metrics will continue during 2018, reaching an EBIT margin of around 8%, adjusted gross leverage trending to 4.5x and liquidity, measured as cash and unused committed credit lines/latest 12 months (LTM) revenues ratio, remaining around 20%.
LATAM's ratings are supported by its diversified business model, important regional market position and adequate liquidity, which are tempered by its still high gross adjusted leverage and operational volatility related to some of its key markets. The ratings also consider the vulnerability of the company's cash flow generation to fuel price variations and the inherent risks of the airline industry, as well as the carrier's capacity to maintain operational margins based on its leadership position in the markets where it operates.
The 'B+'/'RR4' Recovery Rating of the company's unsecured notes reflect average recovery prospects (in the 40% to 45% range) in the event of default. Fitch assumes a going-concern scenario in its recovery analysis for LATAM. .Fitch assumes a going concern enterprise value of $7.6 billion based on post-default EBITDA of approximately $1.37 billion (a 20% discount from the company's 2017 EBITDA level of USD1.7 billion) and a multiple of 5.5x. After deducting 10% for administrative claims, the remaining $6.8 billion of enterprise value leads to full recovery for LATAM's secured debt and approximately 40% to 45% recovery for the unsecured debt, which reflects average recovery prospects consistent with the 'RR4' level.
KEY RATING DRIVERS
Market Position and Diversification Factored into Ratings: Fitch views LATAM's strong business position as sustainable in the medium term, based on its diversification within Latin America and in the international routes between Latin America and either North America, Europe, Oceania, or Africa . The ratings incorporate the company's important market share in Brazil's domestic (second player) and international markets (first player among Brazilian companies), as well as the volatility in operating results associated with these markets through the economic cycle. The company maintains a good business diversification with international passengers, domestic Brazil, domestic Spanish Speaking Countries (SSC) and cargo divisions, representing 45%, 23%, 16% and 11%, respectively, of the company's total revenues in 2017.
Mid-Single Digit Traffic Growth: Fitch expects the company's consolidated boarded passengers to increase by 5% during 2018, an improvement over the 0.3% increase observed in 2017. This view incorporates the expectation that traffic trends for the International segment will continue performing well, a recovery for the traffic levels in the SSC segment, and continued improvement in traffic levels for the Brazilian segment in 2018. Declining yields was one of the key factors affecting LATAM's total revenues and operational margin during 2015 - 2016. The company's consolidated passenger yields increased approximately 6% in 2017. Fitch expects the company's average passenger yields to remain relatively stable during 2018.
Continued Improvement in Operational Margin: Under its base case, Fitch expects LATAM's 2018 total revenues to be approximately USD11 billion, representing a 7.4% increase over 2017, compensating for some increase in fuel cost and resulting in an EBIT margin of 8% in 2018. This expectation represents a continued improvement over the company's operational margins of 6% and 7% during 2016 and 2017, respectively. LATAM plans capacity increases in 2018 of 6% to 8% in the international segment (+4% in 2017), 6% to 8% in the SSC segment (0% in 2017), along with a planned capacity increase of 2% to 4% in the Brazilian domestic segment (after declining -4% in 2017). The Cargo segment should see a recovery in the range of 1% to 3% in 2018 after declining -7% in 2017.
Brazilian Operations Stable
Brazil's better macroeconomic environment in 2018 - 2019 should be reflected in improved traffic levels and stable cost structure for the company's Brazilian operations, which generate approximately 35% of the company's total revenues. Brazil's GDP growth reached 1% in 2017. Fitch anticipates Brazil's economic growth to continue recovering during the forecast period, reaching 2.5% in 2018 and 2.7% in 2019. Fitch expects Brazil's domestic segment traffic (total transported passengers) to reach single-digit annual growth as demand fundamentals and corporate activity continues recovering during 2018 - 2019. LATAM's boarded passengers for its Brazil's domestic operations are expected to reach average annual growth rates in the 3% to 4% range during this period.
Deleverage Trend: LATAM's adjusted gross leverage has declined over the past two years as it has reduced debt and increased margins. The company's gross adjusted leverage, measured as total adjusted debt/EBITDAR, was 5.2x at Dec. 31, 2017, a consistent improvement from 6.4x in 2015. Fitch's base case envisions the company's gross leverage trending to 4.5x by 2019. The company's total adjusted debt was USD12 billion at Dec. 31, 2017. This debt includes USD8 billion of on-balance-sheet debt and USD4 billion of off-balance-sheet obligations related to operating leases with combined rental payments of approximately USD578 million in 2017. Fitch's base case assumes the company's gross on-balance-sheet debt will decline to about USD7.5 billion by year-end 2018.
Neutral to Positive Free Cash Flow (FCF): LATAM maintains a total capex plan that calls for levels of USD1.3 billion per year during 2018 - 2020, which represents a material increase when compared with the company's 2017 capex levels of USD490 million in 2017. Fitch expects LATAM's FCF margin to be neutral to positive during 2018 - 2020 driven by revenue growth, continued EBIT margin improvement, and targeted capex levels. The company's 2018 FCF generation is estimated at USD200 million, representing a 2% FCF margin. 2018 FCF forecast calculation includes USD 1.5 billion in cash flow from operations (after net cash interest paid), USD1.2 billion in total capex; and, paid dividends around USD70 millions.
Strong Credit Linkage: LATAM maintains indirectly all of the economic rights and 49% of the voting rights in TAM, which is an affiliate company of LATAM. The ratings of LATAM and TAM also incorporate the strong credit linkage between both entities with significant legal, operational and strategic ties existing between the two companies. In addition, the financing of the combined fleet plan capex is implemented through LATAM, with the new aircraft being subleased to TAM. Furthermore, the view of strong legal ties existing between LATAM and TAM is supported by cross default clauses incorporated in LATAM's USD500 million unsecured notes due in 2020 and LATAM Finance Limited's USD700 million unsecured notes due in 2024 .
LATAM's 'B+' rating is one notch higher than the ratings of the other two main regional players in Latin America: Avianca Holdings S.A. (B/Stable) and GOL Linhas Aereas Inteligentes S.A. (B/Stable). LATAM is well positioned in the 'B' rating category relative to its regional peers given its diversified business model, important regional market position and adequate liquidity. These positive factors are tempered by the company's still-high gross adjusted leverage and operational volatility related to some key markets. LATAM is rated lower than global players, Delta (BBB-/Stable), United (BB/Stable), and American (BB-/Stable) primarily due to the company's higher financial leverage and weaker profitability.
Liquidity continues to be a credit positive as LATAM has consistently maintained a stronger liquidity position, measured as cash plus committed credit lines over LTM revenues, when compared to regional peers. Fitch anticipates LATAM to maintain a liquidity position around 20% to its expected annual revenues levels during 2018 - 2019. This liquidity position is significantly higher than those levels expected by Avianca Holdings and GOL during the same period.
For 2017, LATAM generated EBIT margins of 7% compared to levels of 9.4% and 6.6% for GOL and Avianca Holdings, respectively. Fitch forecasts LATAM's operational margin will be around 8% during 2018 - 2019. These levels are below to those expected for GOL (10%) and above those expected for Avianca Holdings (6.5%) during the same period. In terms of volatility in their operational performance GOL is viewed as more volatile than LATAM due to GOL's more exposure and concentration to the Brazilian market.
LATAM'S ratings are constrained by its high gross adjusted leverage of 5.2x as of Dec. 31, 2017. This level is in the middle of its regional peer group. Avianca and Holdings and GOL ended 2017 with gross adjusted leverage metrics of 6.4x and 5.6x, respectively. LATAM's adjusted gross leverage has shown improvement in 2017 and is expected to trend to 4.5x by mid-2019.
Fitch's Key Assumptions within Its Rating Case for the Issuer
--2018 - 2019 EBIT margin 8%;
--2018 - 2019 gross adjusted leverage, measured as total adjusted debt to EBITDAR, around 4.5x;
--2018 - 2019 coverage ratio, EBITDAR/(net interest expense plus rents) 2.8x;
--2018 - 2019 Liquidity (measured as readily available cash plus unused committed credit facilities over LTM net revenues), 20%;
--2018 - 2019 neutral to positive FCF generation.
Developments That May, Individually or Collectively, Lead to Positive Rating Action
--Liquidity, measured as cash/LTM revenues, consistently above 15%;
--Gross adjusted leverage consistently approximately 4.5x; neutral-to-positive FCF generation;
--Coverage ratio, measured as the total EBITDAR/(net interest expense plus rents) consistently above 2.5x;
--EBIT margin moving to 8%.
Developments That May, Individually or Collectively, Lead to Negative Rating Action
--Sustained negative FCF;
--Liquidity, measured as cash/LTM revenues, consistently below 10%;
--Gross adjusted leverage consistently above 5.5x;
--EBIT margin consistently below 6.5%;
--Coverage ratio, measured as total EBITDAR/(interest expense plus rents), consistently below 2.3x.
Adequate Liquidity; Cash Plus Revolving Credit at 20% of Revenues: Fitch views the company's liquidity position as adequate for the rating category. LATAM held cash of USD1.7 billion as of Dec. 31, 2017, compared with short-term debt of USD1.2 billion, which includes approximately USD260 million in revolving debt. LATAM's liquidity is expected to remain approximately at USD1.7 billion during 2018 - 2020. LATAM has in place a senior secured revolving credit facility (RCF) of USD 450 million, which was initially at USD275 million as of March 31, 2016. The RCF is collateralized by a combination of aircraft, spare engines and spare parts. Including the RCF, the company's level of liquidity, measured as total cash and marketable securities plus unused committed credit lines over LTM revenues, was 20% as of Dec. 31, 2017. LATAM's financial strategy is to maintain this ratio around 20% during 2018 - 2020.
Negatively factored into ratings, the company's upcoming debt maturities are viewed as high relatively to its expected FCF generation. LATAM faces debt amortizations of USD 0.9 billion and USD 1.3 billion during 2018 and 2019, respectively, which will be primarily addressed through the combination of FCF generation and refinancing. The company's 2018 FCF generation is estimated at USD200 million. Furthermore, the company's coverage ratio, measured as EBITDAR/(net interest Expense plus rents), is expected to be around 2.9x during 2018 -2019.
FULL LIST OF RATING ACTIONS
Fitch has affirmed LATAM's ratings as follows:
LATAM Airlines Group S.A.:
--Long-Term Foreign Currency IDR at 'B+';
--National Equity Rating 'Primera Clase Nivel 3 (cl)'
--USD500 million senior unsecured note due 2020 at 'B+'/'RR4'.
LATAM Finance Limited:
--USD700 million senior unsecured note due 2024 at 'B+'/'RR4'.
--Long-Term Foreign Currency IDR at 'B+';
--Long-Term Local currency IDR at 'B+';
TAM Linhas Aereas S.A.:
--Long-Term Foreign Currency IDR at 'B+';
--Long-Term Local currency IDR at 'B+';
The Rating Outlook has been revised to Positive from Stable.